The ever-shrinking ecosystem of Wall Street safeguards now has a new endangered species, after the Federal Reserve moved to undermine a key restriction on the high-risk practice of funding a bank’s wagers with the same money it would need to pay off any bets that go bad.
Fed governors launched a formal overhaul of the key post-crisis policy on Wednesday, voting 3-0 to begin taking public comment on a proposal to gut the so-called Volcker Rule. The rule restricts a broad category of risky investments known as proprietary trading, or business maneuvers made in a bank’s own interest rather than in service of its clients’ needs. The proposal moving Wednesday would radically reduce the safeguards Congress applied to those trades after the last financial crisis.
Though the change fits neatly into the recent pattern of rapid deregulation of the financial industry under President Donald Trump, the Volcker Rule’s enemies have been swirling and building consensus for this particular set of changes since the regulation was first crafted in 2010.
One of the three Fed governors who voted to advance the proposal Wednesday is a former Obama administration Treasury official. The Fed’s Randal Quarles pointed out that the proposal is “the fruit of long and shared experience” rather than the work of “a few recently appointed individuals.”
Indeed, the Volcker Rule itself is a neoliberal compromise that attempts to straddle the divide between hard-and-fast restrictions on the markets and highly technical, theoretically effective restrictions on the industry’s worst impulses. The rule illustrates the transpartisan nature of financial deregulation over the past four decades: The disastrous trading activities that prompted it were only able to do so much damage because of a devil’s bargain between neoliberal Democrats and conservative Republicans in the late 1990s that destroyed the Depression-era firewall between investment banking and retail banking.
In the 2016 Democratic primary, Hillary Clinton proposed to strengthen the Volcker Rule while Bernie Sanders advocated for restoring the old firewall that would make the rule obsolete. Each candidate’s proposal aimed to provide working-class interests a more absolute protection from the machinations of the pinstriped financier set than what’s in place today. But Wednesday’s move in the opposite direction is more a product of longstanding Washington and Manhattan consensus than of Trump’s 2016 win.
The Fed proposal seeks to frame the changes as relatively minor. Quarles called it “simplifying and tailoring” the rule, implying a no-alarms tinkering in the margins with a rule that’s simply too tedious for the megabanks that dislike it. Not so, said Americans for Financial Reform’s Marcus Stanley in an emailed statement.
“This proposal is no minor set of technical tweaks to the Volcker Rule, but an attempt to unravel fundamental elements of the response to the 2008 financial crisis, when banks financed their gambling with taxpayer-insured deposits,” Stanley wrote.
Both perspectives are basically true. The adjustments the Fed is proposing to the rule would not erase it, but significantly reduce its effect. But that is tantamount to pulling the rule’s effective constraints of megabank self-dealing and risk-taking out of circulation entirely.
The collapse of the housing bubble would have happened with or without the kinds of restrictions that the Volcker Rule contains. But if the ban on wagering with your own bank’s holdings had been in place, the toxic consequences of the mortgage industry’s deceitful practices might have been contained to the banking industry. Instead, it produced a global conflagration fiery enough to destroy trillions of dollars in real-world wealth and financial security for middle- and working-class families.
The Fed proposal would allow banks to miscategorize risky bets with house money as risk-reducing investments, an opposite-day quirk of the deregulatory scheme that Stanley’s group says would make repeats of the 2014 “London Whale” fiasco at JP Morgan more likely. Again, concealed and understated risk was the primary vector that allowed Wall Street’s sloppy and dishonest housing maneuvers to spill out into the Main Street economy and cripple working-class families for generations to come.
Why revert to a system where regulators simply take banks at their word about what’s a market-endangering risk and what’s a safety-enhancing hedge? “Banks now have to submit documentation to prove they are hedging,” Bloomberg reports, “requirements they say are unreasonable.”
Policymaking based on what banks say is reasonable is bad enough. But the other, deeper justifications offered for boring new holes in the Volcker Rule are transparently bogus. Megabanks have started to figure out how to navigate the rule’s requirements in the past couple years, and ratcheted up their risk profiles modestly as a result. They are not able to operate at the same level of daily market exposure as pre-crisis — but that’s the whole point of writing new rules to prevent history from repeating.
When banks really do have a valid case that their house-money trading maneuvers are in the best interests of their clients, they are able to proceed with schemes that would seem on their face to qualify as proprietary trading. As Bloomberg columnist Stephen Gandel recently noted, Goldman Sachs has been able to show that both its Bitcoin trading plans and its proprietary-ish trading in a particular homebuilder’s debts were being done to serve client interests, and thus allowed under Volcker.
Gandel’s examples suggest the supposedly crushing weight of Volcker still leaves smart bankers plenty of room to maneuver in the best interests of their clients. The real reason Wall Street and Trump’s Fed are going after Volcker, he wrote Wednesday, is just that it’s annoying to have to show the government their proprietary work isn’t unduly dangerous.
“The indictment of the Volcker Rule as compelling, but a pain in the ass to police, is sort of an indictment of all laws,” Gandel wrote on Twitter. “[P]rohibiting murder is compelling in its societal impact, but hard to implement.”