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December 3, 2013

Getting the Volcker Rule Done

December is deadline time for one of the most important unfinished pieces of businesses from the Dodd-Frank financial reform legislation: the Volcker Rule. Based on an important intervention by Paul A. Volcker, the former chairman of the Board of Governors of the Federal Reserve System, in late 2009, the “rule,” whose legal intent is enshrined in Dodd-Frank, is simple – end proprietary trading by very large banks.

“Proprietary trading” is the business of betting, using the bank’s own funds, on the direction of markets. When these bets go well, traders and executives are very well paid through bonuses and other mechanisms. But when even a few mega-bets go badly (think mortgage-backed securities), there is a big potential downside risk to the economy, including damage to the bank’s ability to conduct all its ordinary activities (such as making loans to the non-financial sector).

The rule takes aim at the five largest complex financial companies, which have an implicit government backstop as well as insurance from the Federal Deposit Insurance Corporation for their retail deposits. This arrangement presumably encourages reckless risk-taking, including proprietary trading.”

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Read Simon Johnson’s full New York Times Economix blog post here

 
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