Following the passage of the Economic Growth, Regulatory Relief, and Consumer Protection Act (also known as the “Crapo Bill”), a bit of confusion related to the drafting of a change to the Volcker Rule may make the provision apply to only 6 of the over 5,000 U.S. banks:
A summary of the bill promises “community bank relief” to banking entities that have “(1) less than $10 billion in total consolidated assets, and (2) total trading assets and trading liabilities that are not more than five percent of total consolidated assets.”…
The summary appears to communicate that a bank needs to meet both standards in order to get the exemption, but some larger banks are focused on a number of double negatives in the fully amended text that could cloud its interpretation…
Under the “or” interpretation, an institution would in theory only need to meet one of those standards to get an exemption, meaning that banks above $10 billion could still be freed from the regulation as long as their trading assets and liabilities are below 5% of their total assets.
For those unfamiliar with the Volcker Rule (see § 619 of the Dodd-Frank Act), it is a prohibition on “proprietary trading,” when a bank invests in securities using its own, rather than an investors’, money. It also places restrictions on “acquir[ing] or retain[ing] any equity, partnership, or other ownership interest in or sponsor a hedge fund or a private equity fund.”
Curtailing risky lending has a nice ring to it, but there’s a strong case to be made that the Volcker Rule addresses a non-issue. The cause of the financial crisis was a combination of overextended mortgage lending and high leverage by those lenders: Proprietary trading wasn’t part of the picture.
This isn’t to say that proprietary trading can’t yield catastrophic results. For example, J.P. Morgan Chase lost $6 billion in the infamous “London Whale” incident in 2012.
Beyond the ambiguity on the merits of the Volcker Rule, this regulation is still problematic because it, to a certain degree, plays into the narrative that high leverage is business as usual for Wall Street. The failure of a risky investment can set off a chain reaction of default, so we must regulate the investments themselves, the logic goes.
It’s not risky lending per se we should be concerned about. Rather, it’s how such risky investing is funded. If a bank is sufficiently financed by equity, it can take the hit that comes from proprietary trading gone sour. A bank that’s heavily leveraged is another story entirely.
Moreover, this recent wrench thrown into the Volcker rule exposes the vulnerability of complex command-and-control style regulation.
In light of the mixed evidence on the merits of the Volcker Rule, the difficulties inherent in its implementation, and, most importantly, the fact that it matters most how banks finance their investments, a preferable regulatory regime would be a straightforward increase in capital requirements, as proposed by the Minneapolis Plan to End Too Big to Fail.
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