New banking rules in the US, discussing the new Volcker Rule.

There are six big arguments against the Volcker Rule. Here’s why they’re wrong..


Today is the day we finally get to see the Volcker Rule, the new regulation that aims to prevent banks from engaging in speculative trading activity. (See here for an overview.)

Paul Volcker, former chairman of the U.S. Federal Reserve. (Bloomberg)

In all the excitement, a lot of commentators have been writing posts arguing that the Volcker Rule is either unnecessary or perhaps even counterproductive. Both Matt Levine and Tyler Cowen have summed up these cases well.

There are usually six different complaints about the Volcker Rule. By addressing them, we can lay out the case for why this rule is important and worth strengthening. I’ll take the complaints in order from least to most important:

1) “The Volcker rule isn’t a fix-all for Wall Street’s ills, and it might not even be a necessary component of reform. Why are we bothering to do this complicated thing?”

Let’s back up: The Dodd-Frank Act included a series of reforms that were designed to reinforce each other. The ultimate goal is to build a financial system that helps the real economy while also both preventing future crises and having the correct tools to deal with crises when they do happen.

In order to limit the government’s need to act as a safety net during a crisis, regulators are creating various tools that try to do three big things: First, the financial sector will have to internalize some of the costs of crises and insurance. Second, there’s more supervision of banks through things like capital requirements. Third, there are limits on the sorts of activities the banks can do.

The Volcker Rule mainly focuses on the third component — it prevents banks from engaging in “proprietary trading,” which essentially removes the parts of banks that gamble and act like hedge funds, because those parts can blow up quickly (see here for more).

It’s also a conceptual and cultural shift: Banks need to be boring again and focus on their core business lines. As Marcus Stanley of Americans for Financial Reform wrote, the Volcker Rule creates “a new definition of the dealer or market maker role that is more stable and reliable due to the removal of proprietary trading incentives.” This role will still support lending and credit but will also create a new “reliable utility role for dealer banks in the financial markets.”

That’s all just to say that there’s no one single “fix-all” reform here. All three components of financial regulation need to hang together. That involves a well-capitalized banking sector with high leverage, liquidity, and risk-adjusted capital. It also involves a sane over-the-counter derivatives market. And it requires a credible mechanism to force losses on to investors at firms that were previously “Too Big To Fail.” Those components have to work together.

2) “That’s fine, but seriously, this rule would have done nothing useful in solving the last financial crisis. It’s a solution in search of a problem.”

Perhaps. But “solving the last financial crisis” is only one of many goals here. There are other problems that the Volcker Rule does address, at least in part:

First, take resolution authority—the legal regime that’s designed to wind down very large banks and institutions that run into trouble. By preventing banks from engaging in proprietary trading, the Volcker Rule actually makes this task easier. Proprietary trading is notorious for creating quick, large losses, which makes it harder for regulators to deal with failing institutions (resolution authority typically involves nudging banks to better capital while giving regulators the tools necessary to take over failing firms—see more here).

The Volcker Rule also works in concert with other reforms, providing a backstop if those rules don’t work out. If derivatives regulations turn out to be insufficient, for instance, then the Volcker Rule still prevents large banks from carrying out huge bets on tail risk through the derivatives market.

The Volcker Rule would have also helped make the last financial crisis less extreme. “Certainly proprietary positioning played a role in the crisis,” says Caitlin Kline, a former derivatives trader who now works at the non-profit Better Markets. “Banks amassed inventories of high-yielding highly-rated products with largely overnight funding, and this street-wide carry trade helped cause a massive liquidity crisis and then solvency issues, which was a major factor. The Volcker rule will absolutely affect most front-office desk’s ability to warehouse huge positions like that.”


Larry Summers not the best choice for Fed chairmanship

Washington Post.


Larry Summers is among the most prominent public intellectuals on economic topics of our age. He writes columns for the Financial Times, testifies before Congress, and gives speeches before all sorts of groups. Want to hear the Summers take on fiscal policy? Trade? Education? Poverty reduction? He’ll talk about them all day long.

On everything, that is, except the one responsibility that he wants to have for himself, of leading U.S. monetary policy as chairman of the Federal Reserve

At a breakfast sponsored by the Wall Street Journal last month, he attributed his reticence to an old habit acquired when he was Treasury secretary, who by tradition does not comment on the Fed’s monetary policy decisions. But for a man with no shortage of opinions, the real reason is very likely his desire to maintain viability to be named to the Fed chairmanship. And it may, paradoxically, end up costing him the job.

One of the peculiarities of politics in general and the Fed chair job in particular is that the best way to be viewed as a strong candidate for the job is to project general competence while saying very little about how you will actually do the job. It seems a little nuts; if you were applying for a job as CEO of a company, the board would very much want to know what you planned to do if you got the job!

But with a high-profile appointment like for Fed chair or the Supreme Court, vagueness becomes a virtue. When Senate confirmation is the goal, a candidate wants to maintain wiggle room and let people project upon you whatever their preference is.

What Summers is trying to do is to create a situation in which conservative senators view him as a tough, no-nonsense central banker who will maintain the integrity of the dollar against those dirty hippies who want to debase the currency. Simultaneously, he wants liberals to view him as someone who will do whatever he can to try to strengthen job creation and find creative ways to improve growth.

Is monetary policy right now too tight, too loose, or just right? Is the Fed’s strategy of setting thresholds for the unemployment or inflation rates that would trigger interest rate increases a wise one? His silence on these topics, in theory, at least, allows him to have it both ways.

But given how polarized the reaction has been, particularly from Democratic senators, to word of a possible Summers nomination, it may be that merely being vague isn’t enough for Summers. He may have outsmarted himself. Because the other leading candidate for the job, Janet Yellen, helped engineer the Fed’s current efforts to keep monetary policy supportive of growth, and has given numerous speeches articulating her views on monetary policy in detail. If she gets the job, Democrats know what they’re getting in the Fed chair, and most of them like it.

For Summers, on the other hand, because his precise views on policy are unknown, Senate Democrats can only judge based on their view of Summers as a person in deciding whether they will support him — and he is a polarizing figure who has made plenty of enemies in his two decades in the public eye. For the Democratic majority in the Senate, it’s a choice between someone whose views they know and generally approve of (Yellen) or someone whose views they aren’t sure about and whom many of them don’t like very much.

Vagueness can help preserve viability, in other words, except when it hurts.


Haven’t we all taken just about enough fiscal advice from Goldman-Sachs? What’s good for the nation rarely coincides with what’s good for wall street, and Larry Summers has always played for wall street, not for the rest of us. This is not a question of competence, it is a question of economics – which really ought to be called “political economics”. Summers was (is?) in the camp that saw no danger from repealing Glass-Stegall, no danger in consolidation in the financial sector, and has no known problem with the rigged rules of the street. His advice has been geared toward financial sector profits, not financial health for main street let alone prosperity for working people.

Things Larry Summers has correctly predicted: the sun will rise in the east tomorrow, and if I drop this it will fall. Things Summers (like Greenspan) could not predict: if we make it easy for huge corporations to lie, cheat and steal, they will still behave wisely and honorably, and if we let banks use our savings like gamblers in Vegas they will always win at the blackjack table.

Get out of the investment house cesspit for fiscal policy, try out a political economist who genuinely cares about the biggest challenges we face as a nation: persistent high unemployment and growing income/wealth inequality.

akmakm wrote:
July 30, 2013 at 6:35 AM
If Larry Summers is such a smart guy, why has he been dead wrong on everything? It’s like these basketball coaches who have never had a .500 season but they keep getting hired by new teams because they have experience. It was Summers who insisted that Obama under-stimulate the economy when he had a chance to do it right, which would have avoided the 2010 debacle. Summers was behind outsourcing, the repeal of Glass-Steagall, which lead to the 2008 meltdown, and corporate deregulation.

The last 20 years have been a series of disastrous Summers mistakes made necessary by previous Summers mistakes. Obama is giving great speeches about making America work for American workers, but he’s so far into his bubble that he doesn’t seem to realize that it’s painfully obvious to the people hearing that speech that Obama is simultaneously screwing American workers and now he’s desperately trying to bargain away social security and medicare. He’s saying one thing while DOING the opposite and he doesn’t seem to realize that it’s obvious.