This week, the conference committee reconciling the House and Senate versions of financial regulatory reform is set to deal with some of the more contentious aspects of the legislation, including the consumer protection and derivatives titles. Also on the schedule is ironing out differences regarding the Volcker rule, the proposed ban on proprietary trading with federally insured dollars.
The Senate’s version of the Volcker rule is considerably stronger (owing to the idea being formally introduced after the House had already passed its bill), and Rep. Barney Frank (D-MA), who is chairing the conference committee, has indicated that an even stronger version proposed by Sens. Carl Levin (D-MI) and Jeff Merkley (D-OR) is under serious consideration for inclusion.
But of course, the financial services industry is looking to blow holes in the rule, encouraging lawmakers to include all manner of exemptions and carve-outs:
The three main changes under consideration would be a carve-out to exclude asset management and insurance companies outright, an exemption that would allow banks to continue to invest in hedge funds and private equity firms, and a long delay that would give banks up to seven years to enact the changes. In particular, the provisions, sought by Senator Scott Brown, Republican of Massachusetts, and several other lawmakers, would benefit Boston-based money management giants like Fidelity Investments and State Street Corporation.
While the stated intention of lawmakers is not to exempt Wall Street behemoths, that would be the end-result of any carve-outs. For instance, allowing banks to continue investing in hedge funds would allow both Goldman Sachs and Morgan Stanley to hold onto their risky funds. “Once you open up the door just a crack, Wall Street shoves the door open and runs right through it,” said Frank Partnoy, a professor of law at the University of San Diego and a former trader at Morgan Stanley.
It makes sense that opponents of a strict Volcker rule would point to non-Wall Street firms like State Street to make their case. But as Raj Date of the Cambridge Winter Center for Financial Institutions Policy pointed out, State Street is the perfect example of a smaller institution that became systemically important, engaged in risky trading, and needed to be rescued by federal intervention. Thus, the firm should be subject to a proprietary trading ban. The Roosevelt Institute’s Mike Konczal explained further:
The temptation to take a boring business line, like [State Street's] custodial mechanism for record-keeping among equities and bonds, or the boring insurance lines of AIG, and stick a giant hedge fund or shadow bank on top of it is going to be too much for businesses. And when the temptation is too much for businesses, it’s going to be too much for regulators to make the call. Hence why we want to write these rules into the bill, and failing that, as close to the bill as reasonably possible.
As former Federal Reserve Chair Paul Volcker himself said, “the problem with making the exceptions with plausible cases by individual institutions is once you begin, you can never stop. And if you make enough exceptions, you no longer have a rule.”