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Posted at 3:43 PM ET, 01/18/2011

Key study on implementing Volcker Rule released

By Neil Irwin

The nation's most powerful financial regulators published a new blueprint Tuesday for how they will aim to keep banks from engaging in risky, speculative activity.

In a key step in the implementation of the financial reform legislation signed into law last summer, the Treasury Department and bank regulators approved an 81-page study Tuesday of how to implement the "Volcker Rule," the provision of the legislation that aims to keep banks that benefit from a federal government backstop from undertaking risky trading and other investment activities.

The document calls for "robust" enforcement of the law, first proposed by former Federal Reserve chairman Paul Volcker as a step to try to prevent banks from making irresponsible bets that could ultimately necessitate a federal bailout.

"The regulations should prohibit improper proprietary trading activity using whatever combination of tools and methods are necessary to monitor and enforce compliance with the Volcker Rule," said the report, issued at a meeting of the Financial Stability Oversight Council on Tuesday. The council is meant to be a key policy-making body under the new financial reform law, consisting of the Treasury Secretary and the heads of the Federal Reserve, Federal Deposit Insurance Corp., Securities and Exchange Commission and other top financial regulators.

The study emphasizes that regulators will need to be vigilant to keep the institutions they oversee from evading the rules by shifting risky activities around to various arms of their businesses and obfuscating on whether trading in financial markets is done on behalf of clients or with the firms' own money.

Bank CEOs should be required to attest that their firm is honoring the law, the report says, and bank regulators should review trading activity "to distinguish permitted activities from impermissible" and require that banks "implement a mechanism that identifies ... which trades are customer-initiated."

The study was required by the Dodd-Frank act as a key step in turning the concept of the Volcker Rule into specific legislation. The Fed and other bank regulators will still need to proceed with a formal rule-making process to give the ideas embodied in the study the force of law.

By Neil Irwin  | January 18, 2011; 3:43 PM ET
Categories:  Federal Deposit Insurance Corp., Federal Reserve, Financial Stability Oversight Council, Regulation, U.S. Treasury  
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Next: Economic agenda: Wednesday, Jan. 19, 2011


This is such an obvious first step to preventing a repeat of our 2008 financial crisis. Prior to the Volcker rule coming into force, bankers have a "heads they win, tails the taxpayers loose".

The obvious second step is "Too big to fail equals too big to exist".

Posted by: Anonymous | January 18, 2011 5:29 PM | Report abuse

I hope this works out, but the strightforward way to handle this risk is the way Glass and Steagall wrote into the Act that created the FDIC. In 1933, the hazard inherent in allowing banks to take riskks with insured depositor assets was obvious to Congress: if allowed to invest with insured assets, the banks would, quite naturally, use deposit insurance to transfer that risk from themselves to the tax payers. It was for this reason that the Glass-Steagall Act imposed a separation of investment banking from commercial banking.

I don't know what the exact definition of "risky trading and other investment activities" amounts to, but it seems to me that federally-insured assets should be protected against any and all sorts of speculation, and restricted to mortgage lending and other sorts of banking we once described as "traditional."

The Volcker rule seems well-intentioned, but inadequate. If the US tax payers are going to insure bank deposits, then not one thin dime of those deposits should be used for speculative investment. Defining "risky" as a policy issue entails debating the definition of "risky" as a political issue, and political debates in the currently prevailing political environment tend to stray arrantly from any sort of basis in fact. Defining "risky" for the purposes of the Volcker rule is an exercise best assisted by hindsight.

Quite apart from the difficulty of defining the acceptable threshold of risk for the Volcker rule is a core ethical issue: protecting taxpayer-insured funds from unnecessary risk is simply the ethically correct thing to do. Sometimes it's not good enough to do what we can get away with; sometimes, and, I think, this time, it can be important to simply do what is right.

Posted by: lonquest | January 18, 2011 5:36 PM | Report abuse

This is such an obvious first step to preventing a repeat of our 2008 financial crisis. Prior to the Volcker rule coming into force, bankers have a "heads they win, tails the taxpayers loose".

The obvious second step is "Too big to fail equals too big to exist".

Posted by: Anonymous | January 18, 2011 5:44 PM | Report abuse

From the account given here, it looks like the "blueprint" for enforcement of the Volcker Rule is as vague and platitudinous as the original legislation, adding virtually no clarity or specificity at all. It probably could not have been otherwise given the way the law plainly intends that everything be up to the judgment of the regulators, (the legislators being too confused and cowardly to put forth actual solutions on their own). The danger, with inevitable consequences in my opinion, is that the regulators will be quickly captured by the special interests they regulate and new abuses will blossom like dandelions in the financial field.

Posted by: Adam_Smith | January 19, 2011 8:19 AM | Report abuse

I have just skimmed through the 81-page study. It is mostly a compilation of excuses why it is hard to distinguish prohibited proprietary trading, when not done at a desk specifically intended for that purpose, from permitted banking activities incidental to market making, underwriting and hedging on behalf of clients. Some "indicia" for distinguishing what is permissible from what is not are given, but they are imprecise and inconclusive.

We should have restored Glass-Steagall.

Posted by: Adam_Smith | January 19, 2011 8:48 AM | Report abuse

After reading the 81 page study it seems obvious that regulatory capture is already in full swing. The TBTF banks are successfully watering down the "alleged restrictions" on their activity by convincing the Regulators to twist the meaning of words to protect the TBTF banks. I would like to know how the FSOC intends to allow a bank with 9.5% of all the liabilities in the financial sector to fail. Simply stated such a bank would once again threaten the stability of the system and they will bail them out once again. Let's bring back Glass Steagall and start enforcing the existing anti-trust laws.

Posted by: Anonymous | January 19, 2011 1:32 PM | Report abuse

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