On Wednesday, former Federal Reserve Chairman Paul Volcker testified before the Commission on Banking Standards of the U.K. Parliament, a commission that seems to be composed mostly of members of the Treasury Committee, to discuss the Volcker Rule and a wide range of other issues related to the role of the banking industry in the financial crisis of 2008.
Volcker was asked to provide his views on the various proposals that have been made to rein in the trading activities of banks — the Volcker Rule in the United States, the Vickers plan in the United Kingdom and the Liikanen rule in the European Union.
The vast bulk of activity occurs in the United States and the United Kingdom, although Volcker allowed that trading activities could one day grow enough in the European Union to pose a threat to international financial stability.
The Volcker Rule is based on prohibiting proprietary trading, except for hedging and market making, whereas the Vickers plan attempts to ringfence the activities by putting them within a separate entity.
Volcker said he wished that both the United States and the United Kingdom had adopted the same rule, but there might be some value in competition to see which rule will work better.
He traced the evolution of the Glass-Steagall Act in the United States from a simple rule to one that grew in complexity and permissiveness, and he attributed this change in large part to advances in technology that made it easier for banks to interact.
All told, Volcker questioned whether all of the trading activity had contributed anything of value, and he suggested that the banking industry had contributed little to the economy beyond the services provided by the ATM machine.
In response to complaints about the complexity of the rule, Volcker attributed them to a parody circulated by industry lobbyists that the rule is 300 pages long.
Actually, he said, it is only 35 pages long, with the rest attributed to an appendix of about the same length and 160 pages generated by requests from banking lobbyists for clarification as to what would be considered proprietary trading and market making.
Volcker stressed that the rule should be simple and based on the principle that the safety net should only apply to the activities of banks that confer social benefits, such as lending, deposit taking and payments. Investment banking and related activities, in his view, might be useful to the economy, but they could be provided by investment banks, hedge funds and private equity without government support.
Another idea of Volcker’s arises from his view that the Basel capital rules took too long to develop, are too complex, relied too much on credit ratings and internal models and exempted sovereign debt and mortgages — both of which turned out to be problematic.
Volcker would impose a leverage ratio akin to the basic capital standard that applied decades ago, significantly higher than what is proposed as the capital standard under Basel III.
Viewers of this hearing and of hearings before the Treasury Committee might detect a difference in the amount of deference given by the parliamentarians to the representatives of the industry and to the industry regulators who appear before them. In the aftermath of the Libor scandal, there have been resignations of industry executives, and perhaps a few regulators, most notably the departure of Bob Diamond, the American who ran Barclays.
The proximate cause of his ouster, as aired before the Treasury Committee, was that he had pushed too hard for the greatest possible running room under the regulations and had lost the confidence of the regulators.
In the case of the departure of Vikram Pandit from Citigroup this week, some chatter along these lines has come out, but Sheila Bair, former chairwoman of the FDIC, has told of being undermined by her fellow regulators at the Fed and the Office of the Comptroller of the Currency when she searched for a way to discipline Citi.
It may be instructive to look for these cultural clues as U.S. and U.K. authorities struggle to determine how to fulfill commitments to strengthen regulation against the background of decades of history of the industry being able to defeat any regulatory effort, even if it took a decade to accomplish this.
Executives of the leading banks and trade associations seem to know that they are still in charge of policy despite the occasional huffing and puffing of former regulators and current critics.
Robert Feinberg served on the staff of the House Banking Committee for 10 years that encompassed the savings-and-loan debacle and the beginning of its migration to the banking sector. Subsequently, he has consulted on issues related to the crisis for law firms, accounting firms, securities firms, and trade associations.
Feinberg holds a BS.E. from the Wharton School and a J.D. from the Law School of the University of Pennsylvania. He has drafted dissenting views on landmark banking legislation, contributed to a financial blog, and written hundreds of reports for clients to document the course of the financial crisis as it has unfolded over the past three decades.
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