Today, former Federal Reserve Chairman and Obama administration adviser Paul Volcker appeared before the Senate banking committee to discuss the “Volcker rule,” which is the Obama administration’s proposal to bar deposit taking financial institutions from engaging in proprietary trading (trading for their own benefit, not for any particular customer).
As the Wall Street Journal reported, the bank’s themselves are gearing up to fight the rule. And they seem to have a few allies in the Senate, where one line of criticism today was that the Volcker rule would not have prevented the 2008 financial crisis, since the popular culprits — AIG, Lehman Brothers, Bear Stearns — were not commercial banks and thus would have been unaffected.
Volcker addressed this criticism by explaining that, first, the administration is not claiming that this rule, in isolation, will shore up the financial system. It’s merely one part of a wider regulatory reform effort, including a resolution authority for dismantling failed, systemically risky firms without using taxpayer money.
But second, Volcker noted that we currently have a banking system where all of the large institutions are essentially subsidized by the taxpayer and can gamble with taxpayer backing, which is an untenable situation. So the Volcker rule is as much about correcting this as reacting to the last crisis. He even told Sen. Mike Johanns (R-NE) that should another financial crisis occur because new rules were not put in place “my soul is going to come back and haunt you”:
What I want to get out of the system is taxpayer support for speculative activities. And I want to look ahead. If you don’t bar that, it’s going to become bigger and bigger and it adds to what is already a risky business…The problem today is look ahead and try to anticipate the problems that may arise that will give rise to the next crisis. And I tell you, sure as I am sitting here, that if banking institutions are protected by the taxpayer and they are given free rein to speculate, I may not live long enough to see the crisis, but my soul is going to come back and haunt you.
While the Volcker rule would not have stopped Lehman Brothers from blowing itself up, as the New York Times pointed out, at conglomerates like Citigroup and Bank of America “proprietary trading, mainly in risky mortgage-backed securities, precipitated the credit crisis in 2008 and the federal bailout.” All of the banks were engaged in slicing and dicing mortgages, not for the benefit of their customers, but to bolster their own bottom lines. This is the sort of activity that the Volcker rule is aimed at.
And Volcker’s point about trying to prevent the next mess is important. During the financial crisis, all of the big investment banks (including Goldman Sachs and Morgan Stanley) became bank holding companies, which gives them access to federal guarantees and cheap loans. They still have those federal guarantees today and reportedly have no intention of giving them up. So they’re able to engage in all their usual high-risk trading, with money backed up by the taxpayer and none of the drawbacks of commercial lending. So it’s no coincidence that the big trading banks once again have booming profits while the institutions with more commercial lending are still stuck in the doldrums.
Sen. Chris Dodd (D-CT), firing back at reports that he would water down the rule, said today that “I strongly support this proposal. I think it has great merit.” Indeed, while no one step would have prevented the entirety of the financial crisis, that’s no reason for failing to put in safeguards that would have helped and that will make for a more secure system going forward.