Critics Slam Volcker Rule as 'Worst of All Worlds'

Following the announcement, financial reform advocates cautioned those who celebrated the agreed-upon rules as a "major defeat for Wall Street," by saying that by providing flexible exemptions and self-reporting compliance, the lukewarm deal was "the worst of all worlds."

Known to critics as "Glass-Steagall-lite," section 619 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (called the "Volcker Rule" after Paul Volcker, the former chairman of the Federal Reserve), claims to establish a firewall between commercial lending and investment banks by preventing big banks from making proprietary trades for their own profit.

Following the 2010 passage of Dodd-Frank, the details of this section had to be crafted jointly by five banking regulators--the Federal Reserve, the Federal Deposit Insurance Corporation (FDIC), the Office of the Comptroller of the Currency (OCC), the Securities and Exchange Commission (SEC), and the Commodity Futures Trading Commission (CFTC).

After three and a half years, the groups announced in a joint statement Tuesday completion of the task:

The final rules prohibit insured depository institutions and companies affiliated with insured depository institutions ("banking entities") from engaging in short-term proprietary trading of certain securities, derivatives, commodity futures and options on these instruments, for their own account. The final rules also impose limits on banking entities' investments in, and other relationships with, hedge funds or private equity funds.

However, the group notes, there are exemptions for certain activities, "including market making, underwriting, hedging, trading in government obligations, insurance company activities, and organizing and offering hedge funds or private equity funds."

Many claim the rules' 800+ pages and overly-flexible exemptions will provide cover for the big banks to continue business as usual.

"The 'Volcker Rule' represents Glass-Steagall-lite," writes William Black, former bank regulator and associate professor of economics and law at the University of Missouri-Kansas City. "It cannot work because it avoids doing what Glass-Steagall did," he writes, by clearly separating "what was permissible from what was forbidden."

"In an effort to limit the evasions that are made inevitable by its failure to act boldly and ban derivative derivatives, [the rule] will reportedly be over 850 pages," Black continues. "It will be a nightmare for bank examiners and honest banks, yet the big cheating banks will easily evade it by calling their speculation 'hedging.'"

"The result will be the worst of all worlds," he adds.

Further, as independent financial reporter David Dayen writes in the New Republic, by allowing big banks to engage in "market-making," the Volcker rule opens to the door to "back-door proprietary trading":

[T]he legislative statute allows banks to engage in "market-making," facilitating trades for clients in stocks, bonds or other securities. Merkley analogizes this to banks operating like a grocery store, keeping enough bread in stock in case customers request it . "It doesn't mean you can buy a warehouse full of the bread and bet on the price changing," Merkley said. Market-making generated $44 billion for the five biggest banks just last year, as they profit from holding the stocks and bonds for a short while. Reformers fear that banks will label virtually every asset they purchase as inventory for market-making, turning it into back-door proprietary trading.

Further, the rule may also give banks discretion to decide for themselves whether their trades are permissible.

According to the joint press release, compliance with the rule is determined by the size of the operation. Those with "significant trading operations" must establish a compliance program where bank CEOs will be required to "attest that the program is reasonably designed to achieve compliance with the final rule."

Citing a similar certification that could have been used during the financial crisis to send non-compliant CEOs to jail, Dayen writes: "Given that history, and the fact that the certification here is even weaker, it's hard to see it as much more than lip service."

"Whoever is the primary supervisor has enormous discretion about how this [rule] will affect trading," Marcus Stanley, the policy director at Americans for Financial reform, toldMother Jones. He added that the final Volcker rule "does not include transparency provisions that would allow the public to judge whether banks are complying."

With Reuters reporting that Wall Street banks are already preparing to wage a legal battle against the new rule, observers note that any analysis--whether celebratory or critical--is premature.

As Dayen writes:

[I]f you view financial reform like a football game, today's votes kick off the third quarter of a contest destined for 34 consecutive overtimes. Today's vote mostly triggers an extended period of data collection and guideline-setting, giving mega-banks many future opportunities to water down the rules. And even if implementation wraps up strongly--as it certainly could--regulatory spine will be needed to prevent another financial crisis. As [Volcker rule co-author Senator Jeff] Merkley noted, in matters like this, "you need eternal vigilance." And, in Washington and on Wall Street, vigilance has often been anything but.

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