The Internal War Over the Volcker Rule

The reason it has taken so long is because the market cops and the bank cops can’t agree on what it should say.

Paul Volcker, chairman of the President's Economic Recovery Advisory Board, participates in a Senate Banking, Housing and Urban Affairs Committee hearing on Capitol Hill on February 2, 2010 in Washington, DC. The committee was hearing testimony on prohibiting high risk investment activities by banks and holding Companies. 
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Nov. 16, 2013, 4 p.m.

The so-called Vol­ck­er Rule, a pro­vi­sion in the 2010 Dodd-Frank fin­an­cial-re­form law that would ban banks from mak­ing risky bets with their own money, was sup­posed to be ready in 2011. And the fed­er­al gov­ern­ment did re­lease a lengthy pro­pos­al laden with hun­dreds of ques­tions from Wall Street and chased by thou­sands of com­ment let­ters. Then, the fi­nal rule was sup­posed to be ready in 2012. Now it’s sup­posed to be ready in 2013. “I think that it’s close,” Mary Miller, the Treas­ury De­part­ment’s un­der­sec­ret­ary for do­mest­ic fin­ance, said last week. Mean­while, reg­u­lat­ors have come and gone in the agen­cies writ­ing the rule. What, ex­actly, is the hol­dup?

The biggest prob­lem hasn’t been the dif­fi­culty of de­fin­ing which trades are per­miss­ible un­der the Dodd-Frank stat­ute. (Hedging and mar­ket-mak­ing — in which a firm says it will buy and sell stocks at a giv­en price — are OK; mak­ing risky bets for profit, known as “pro­pri­et­ary trad­ing,” is not. The line between them, Wall Street and reg­u­lat­ors ar­gue, is fuzzy.) The prob­lem hasn’t even been the stu­pefy­ing amount of work Dodd-Frank handed to reg­u­lat­ors, who must de­vise 398 rules, ac­cord­ing to law firm Dav­is Polk & Ward­well, without giv­ing all the rel­ev­ant agen­cies enough of a fund­ing boost for the job. Three years in, and they’re still only 40 per­cent there.

No, say Wall Street and former Wash­ing­ton of­fi­cials: The biggest prob­lem may be the cul­tur­al gaps between the five agen­cies charged with writ­ing the Vol­ck­er Rule. It’s not the first time reg­u­lat­ors have had to work to­geth­er, but such col­lab­or­a­tion — par­tic­u­larly between bank­ing cops and mar­ket cops — was less fre­quent be­fore Dodd-Frank. It is ex­pec­ted to be­come more com­mon, and the Vol­ck­er Rule ex­per­i­ence sug­gests that it won’t be easy.

The Dodd-Frank stat­ute con­venes the Fed­er­al Re­serve Board, the Fed­er­al De­pos­it In­sur­ance Corp., the Of­fice of the Comp­troller of the Cur­rency, the Se­cur­it­ies and Ex­change Com­mis­sion, and the Com­mod­ity Fu­tures Trad­ing Com­mis­sion. To­geth­er, they are meant to write the rule, named for Paul Vol­ck­er, the former Fed chair­man and a re­form ad­voc­ate. That means they’ve got to get every­one on board, and any agency can hold up the pro­cess over any point. This has pro­duced frus­trat­ing delays, Vol­ck­er said at a con­fer­ence in March. “How many times people told me six months ago, ‘It’ll be two weeks, Paul! We’re go­ing to get the reg­u­la­tion out. It looks like it’s right there.’ Doesn’t hap­pen,” he said. “Two months later, ‘Well, be­fore the end of Decem­ber.’ ‘Well, be­fore the end of Janu­ary.’ You can­not op­er­ate an ef­fect­ive reg­u­lat­ory sys­tem this way.”

The greatest cul­tur­al di­vide is between the three bank­ing reg­u­lat­ors (the Fed, the FD­IC, and the OCC) on one side and the two mar­ket reg­u­lat­ors (the SEC and the CFTC) on the oth­er. The bank­ing types have his­tor­ic­ally worked con­fid­en­tially to ex­am­ine in­sti­tu­tions’ prac­tices and cor­rect them when they’re out of line; these of­fi­cials co­oper­ate and even em­bed staff at the banks them­selves, so it stands to reas­on they prefer flex­ib­il­ity on this rule and oth­er parts of fin­an­cial-reg­u­lat­ory re­form, say former of­fi­cials and fin­an­cial-reg­u­la­tion ex­perts who asked to speak an­onym­ously in or­der to gen­er­al­ize. The mar­ket reg­u­lat­ors, on the oth­er hand, are fo­cused on in­vestor pro­tec­tion and dis­clos­ure; they like to draw bright, eas­ily en­force­able lines, the of­fi­cials say.

Dodd-Frank asks reg­u­lat­ors from both sides to draw this line to­geth­er in 58 dif­fer­ent places, most not­ably the Vol­ck­er Rule and a risk-re­ten­tion pro­vi­sion re­lated to mort­gages, which con­venes the OCC, the Fed, the FD­IC, the SEC, the Fed­er­al Hous­ing Fin­ance Agency, and the Hous­ing and Urb­an De­vel­op­ment De­part­ment. As with the Vol­ck­er pro­vi­sion, those agen­cies re­leased their first pro­pos­al in 2011 but have yet to fi­nal­ize any­thing.

The bank­ing reg­u­lat­ors have ex­per­i­ence work­ing to­geth­er. Dav­id Barr, a spokes­man for the FD­IC, said it was “very com­mon” for the FD­IC, the Fed, and the OCC to work to­geth­er on joint rules, even be­fore Dodd-Frank. He points to the Fed­er­al Fin­an­cial In­sti­tu­tions Ex­am­in­a­tion Coun­cil, a gov­ern­ment or­gan­iz­a­tion cre­ated in 1978 with a mis­sion to “make re­com­mend­a­tions to pro­mote uni­form­ity in the su­per­vi­sion of fin­an­cial in­sti­tu­tions.” The SEC and the CFTC have also col­lab­or­ated be­fore, is­su­ing a joint rule­mak­ing un­der the Com­mod­ity Fu­tures Mod­ern­iz­a­tion Act of 2000, for ex­ample.

The big­ger shift is the one that re­quires bank­ing and mar­ket reg­u­lat­ors to work to­geth­er. This isn’t the first time they’ve had to do so, and it didn’t go very well last time: In Gramm-Leach-Bli­ley, the 1999 bank­ing law, the SEC was re­quired to write ex­emp­tions for banks defined as “brokers” by the Se­cur­it­ies Ex­change Act of 1934. A turf war with the Fed led to an­oth­er law re­quir­ing the two agen­cies to is­sue joint rules. Over­all, the pro­cess took eight years.

Such joint work is ex­pec­ted to ac­cel­er­ate un­der Dodd-Frank and bey­ond. “The reg­u­lat­ory sys­tem is sort of back in the days of Glass-Steagall [the 1933 law that banned com­mer­cial banks from the in­vest­ment busi­ness], where we have our mar­ket reg­u­lat­or over here and our bank reg­u­lat­or over there, and the as­sump­tion [that] the busi­nesses are very dif­fer­ent. But, in fact, they’ve in­ter­pen­et­rated a lot,” says Mar­cus Stan­ley, policy dir­ect­or at the pro-re­form group Amer­ic­ans for Fin­an­cial Re­form. To over­see mod­ern fin­an­cial mar­kets, this in­ter­agency col­lab­or­a­tion is a ne­ces­sary de­vel­op­ment, he says.

Wheth­er the cul­tur­al com­ing-to­geth­er will muddle the fi­nal Vol­ck­er Rule is un­known; reg­u­lat­ors have been se­cret­ive about the de­tails. But the 298-page pro­pos­al re­leased in Oc­to­ber 2011 didn’t as­suage that fear (Vol­ck­er dryly re­ferred to it as “not a mas­ter­piece of clar­ity”). Re­form ad­voc­ates worry that a sprawl­ing, com­plex rule would be harder to en­force and easi­er for banks to sidestep. But that could be the in­ev­it­able res­ult of an in­ter­agency com­prom­ise.

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