Banks Need Volcker Rule's Degree of Difficulty

(Bloomberg Opinion) -- The Volcker Rule was apparently too hard for its own good.

The Federal Reserve’s governors voted on Wednesday to seek comment on watering down the post-financial crisis Dodd-Frank regulation that drastically limited the ability of banks, particularly the biggest ones, to make bets with their own capital. The most notable proposed change is that regulators would have to prove that a trade or a bank’s trading strategy was in fact a so-called proprietary trade. Under the current rule, the burden was on the banks to constantly justify that their trading was compliant.

Banks Need Volcker Rule's Degree of Difficulty

As I said two weeks ago, this change could be a good thing. The rule had become entirely about process and not about its original intent. Proprietary trading is still curbed. Putting the onus back on regulators to police Volcker might encourage more enforcement, not less. The list of banks fined so far under Volcker is short: Deutsche Bank, and that’s it.

But the reason cited for trying to roll back Volcker is odd. Lael Brainard, a Fed governor who was appointed by President Barack Obama and who has been a strong advocate of tough bank regulation in the past, voted for the change, saying, “While the purpose of the Volcker Rule is compelling, our experience with its implementation suggests the inter-agency rule has turned out ot be needlessly cumbersome in practice.”

That seems like an indictment of not just the Volcker Rule but any rule the government makes. Outlawing violent crime is compelling from a societal standpoint but difficult to police in practice. Yes, Brainard throws in the “needlessly cumbersome” part, but how does she know that. The way the Volcker Rule policed prop trading was through its cumbersomeness. And it worked. Prop trading is down.

Banks Need Volcker Rule's Degree of Difficulty

Ever since the financial crisis, and the passage of Dodd-Frank, debate has been growing about the best way to regulate banks. One method is to put in a lot of rules that limit risky behavior. The other is to force banks to hold a lot of capital, as much as 25 percent of assets — in the run-up to the financial crisis, capital ratios had shrunk as low as 3 percent — and leave the rest up to them. There is an argument to be made that Dodd-Frank saddled banks with too much of the first. And there has been some support on both sides of the aisle, from both Democratic Senator Elizabeth Warren and Republican Representative Jeb Hensarling, for more of the latter.

For effective bank regulation, you need to do one or the other. The easing of the Volcker Rule would normally seem to suggest that the Trump administration’s regulators prefer the second path. But that’s wishful thinking. The White House has shown zero inclination to raise the capital bar while stripping away other rules, which means we can use all the cumbersomeness we can get. 

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