As 2009 rolled on and the panic receded, Paul Volcker felt there was something very wrong with the Obama administration's plans for reforming Wall Street. But no one was listening to him. The gruff-voiced, cigar-chomping former Fed chairman may have been nominally a member of the Obama team—chairman of the president's new Economic Recovery Advisory Board—as well as a living legend of finance, the conquerer of runaway inflation in the '70s. But the then-82-year-old Volcker found that his rep wasn't getting him anywhere with the president's inner circle, especially Obama's bank-friendly Treasury secretary, Tim Geithner, and chief economic advisor Larry Summers, both of whom had little time for him. In an interview in late 2009, Volcker said he felt somewhat used early on by Obama (whom he had publicly backed for president)--merely trotted out for the cameras during the presidential campaign, but then sidelined when the real decisions were being made. "When the economy began going sour, then they decided I could be some kind of symbol of responsibility and prudence of their economic policy," he said with a wry smile.
What bothered Volcker was very simple: After hundreds of billions of dollars in taxpayer bailouts, he was appalled that the biggest banks--which Obama allowed to remain intact even though they had caused the worst financial crisis since the Great Depression--were being permitted to resume their pre-crisis habits of behaving like hedge funds, trading recklessly with taxpayer-guaranteed money. Volcker wanted a rule that would bar commercial banks from indulging in "proprietary" trading (in other words, gambling with clients' money for the firm's own gain), thus cordoning off federally guaranteed bank deposits and Federal Reserve lending from the heaviest risk-taking on the Street. It was the closest thing he could get to a return of Glass-Steagall, the 1933 law that forced big banks like J.P. Morgan to spin off their riskier investment banking sides into new firms (in that case, Morgan Stanley) after the Crash that led to the Depression. Commercial banks that lie at the heart of the economy and are able to draw cheap money from the Fed discount window "shouldn't be doing risky capital market stuff," Volcker told me. "I don't want them to be Goldman Sachs, running a zillion proprietary operations." But the president "obviously decided not to accept" his recommendations, Volcker said then.
Channeling the views of Wall Street, Geithner and Summers thought Volcker's proposals were not feasible: How was anybody supposed to know when a trade was "proprietary" as opposed to a legitimate hedging or "market-making" transaction for clients. Just couldn't work, they said. And so Volcker began traveling all over the country to deliver a series of speeches pushing for even more fundamental reform of the financial system--parting ways with both the Obama administration and most of the Congress.
By late 2009 and early 2010--especially after the stunning special Senate election result in Massachusetts gave the once-Democratic seat to a Republican, Scott Brown--Obama began to think that his administration looked vulnerable on the issue. According to a senior administration official involved in economic policy-making, the president came to believe that Geithner and Summers hadn't gone far enough with financial reform. They had, in fact, resisted almost every structural change to Wall Street, not only Volcker's plan but also Arkansas Sen. Blanche Lincoln's idea to bar banks from swaps trading. And Wall Street didn't seem to be changing on its own: In December 2009, the president was outraged to hear that year-end bonuses would actually be larger in 2009 than they had been in 2007, the year prior to the catastrophe. "Wait, let me get this straight," Obama said at a White House meeting. "These guys are reserving record bonuses because they're profitable, and they're profitable only because we rescued them." And so at a meeting late that year in the Roosevelt Room, Obama said: "I'm not convinced Volcker's not right about this." Vice President Joe Biden, a longtime fan of Volcker's, bluntly piped up: "I'm quite convinced Volcker is right about this!"
Obama formally proposed the rule at a White House news conference on Jan. 21, 2010 with Volcker in rare attendance, announcing: "We're calling it the Volcker Rule after the tall guy behind me." Senators Jeff Merkley, D-Ore., and Carl Levin, D-Mich, later formally introduced the rule into the Dodd-Frank law. But even then Geithner dragged his feet on implementation, and for the next two and a half years Wall Street lawyers loaded the proposal down with loopholes and exemptions.
The Volcker Rule was, in fact, in grave danger of being loopholed to death right up until its adoption this week. And in the end it was largely one regulator, more than any other, stood firm against those efforts and managed to avert the worst of the watering down: Gary Gensler, the outgoing chairman of the Commodity Futures Trading Commission. As diminutive in stature as Volcker is towering, Gensler was the Jeff to Volcker's Mutt, an essential part of a de facto team.
Like Volcker, the 56-year-old Gensler was also something of a relic from an earlier era, not necessarily the person you would expect to be taking on Wall Street in the second decade of the 21st century. Serving under Treasury Secretary Robert Rubin in the '90s, Gensler had helped to open the way to massive deregulation of the banks, ultimately leading to the subprime mortgage crisis. As a result, progressive senators such as Bernie Sanders, I-Vt., and Maria Cantwell, D-Wash., even put on a hold on his CFTC nomination at first. But in testimony and later on in interviews, Gensler became one of the very few former Clinton or Bush administration officials to admit his errors of judgment in freeing up finance in the '90s. And as CFTC chief, he sought to make right what had gone so terribly wrong.
It was Gensler, using the unmatched expertise he had developed in the previous three years cracking down on over-the-counter derivatives trading--which is the main source of the banks' proprietary profits--who mainly led the charge to toughen the Volcker Rule and extend it worldwide, especially when it became clear that banks could evade it by shifting trading to their overseas operations, by several accounts. Along with Securities and Exchange Commissioner Kara Stein, he was also the key player behind a critical provision that places the burden of proof on the banks to justify that activities they are engaged in are not proprietary trading, forcing them to provide a regular analysis correlating such trades to appropriate hedges or other approved activities. Giving additional teeth to the rule, Gensler and the other regulators also forced the banks to restrict their hedging to specific identifiable investments and ban so-called portfolio hedging--which had allowed the banks to engage in complicated trades putatively to hedge against general risks across a broad portfolio of investments. Gensler held up as a cautionary tale the notorious "London Whale" episode, when even a blue-chip bank like JPMorgan was found to be making derivative bets that cost $6.2 billion in losses and masking them as a portfolio hedge. Gensler "went to the mat on that issue," says Michael Greenberger, a University of Maryland regulatory expert and a sometime advisor to the CFTC.
By taking the baton from Volcker, and pushing almost alone to regulate trillions in derivatives trades overseas, Gensler initially earned himself enemies in the Treasury Department and White House, especially when European and Asian governments began complaining about his efforts to extend his purview to U.S. banks' overseas activities. Helped by in the end by Treasury Secretary Jacob Lew, who proved much more eager to endorse his efforts than Geithner had been, Gensler won over less enthusiastic regulators. In a recent speech that could almost have been written by Gensler, Lew praised the rule as "true to President Obama's vision" and echoed Gensler in saying that it was intended to prohibit "risky trading bets like the 'London Whale' that are masked as risk-mitigating hedges."
Now, with little fanfare, Gensler is on his way out at the CFTC--perhaps the most unsung hero of the entire post-financial crisis period--and the effectiveness of the Volcker Rule remains to be seen, especially since regulators have put off implementation until 2015. The banks will no doubt sue to change it further. But even some skeptics of Dodd-Frank think it could be the biggest breakthrough yet against the concentrated power of Wall Street banks. It "will not end all gambling activities on Wall Street, but should limit them and reduce the risk to Main Street," Dennis Kelleher, the head of the advocacy group Better Markets, said in a statement. Thanks largely to the odd couple of Paul Volcker and Gary Gensler, the rule may yet prove to be the single most effective solution to the too-big-to-fail problem.