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December 11, 2013

There are six big arguments against the Volcker Rule. Here’s why they’re wrong.

Today is the day we finally get to see the Volcker Rule, the new regulation that aims to prevent banks from engaging in speculative trading activity. (See here for an overview.)

In all the excitement, a lot of commentators have been writing posts arguing that the Volcker Rule is either unnecessary or perhaps even counterproductive. Both Matt Levine and Tyler Cowen have summed up these cases well.

There are usually six different complaints about the Volcker Rule. 

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2) “That’s fine, but seriously, this rule would have done nothing useful in solving the last financial crisis. It’s a solution in search of a problem.”

Perhaps. But ‘solving the last financial crisis’ is only one of many goals here. There are other problems that the Volcker Rule does address, at least in part:

First, take resolution authority—the legal regime that’s designed to wind down very large banks and institutions that run into trouble. By preventing banks from engaging in proprietary trading, the Volcker Rule actually makes this task easier. Proprietary trading is notorious for creating quick, large losses, which makes it harder for regulators to deal with failing institutions (resolution authority typically involves nudging banks to better capital while giving regulators the tools necessary to take over failing firms—see more here).

The Volcker Rule also works in concert with other reforms, providing a backstop if those rules don’t work out. If derivatives regulations turn out to be insufficient, for instance, then the Volcker Rule still prevents large banks from carrying out huge bets on tail risk through the derivatives market.

The Volcker Rule would have also helped make the last financial crisis less extreme. ‘Certainly proprietary positioning played a role in the crisis,’ says Caitlin Kline, a former derivatives trader who now works at the non-profit Better Markets. “Banks amassed inventories of high-yielding highly-rated products with largely overnight funding, and this street-wide carry trade helped cause a massive liquidity crisis and then solvency issues, which was a major factor. The Volcker rule will absolutely affect most front-office desk’s ability to warehouse huge positions like that.””

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Read full Washington Post article here

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