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January 25, 2012

Trying to define the 'Volcker rule'

With attention focused on the November elections, Wall Street is looking to reshape a crackdown on banks that was spearheaded by President Barack Obama.

Regulators have stewed over how to enforce a deceptively simple part of the 2010 Dodd-Frank financial reforms — the “Volcker rule,” named after former Federal Reserve Chairman Paul Volcker — that curbs banks from trading for themselves.

Obama cheered the rule two years ago, saying it would stop banks that have government-insured deposits from putting the economy at risk. But financial-sector lobbyists now warn that any missteps in crafting the final guidance for the rule could endanger the stock and bond markets.

“Congress has effectively asked them to umpire a baseball game without knowing what the rules of baseball are,” said Tom Quaadman, vice president of the U.S. Chamber of Commerce’s Center for Capital Market Competitiveness. “You have regulators acknowledging that they don’t understand issues in the marketplace.”

Any decision will most likely take place away from the glare of the campaign trail, where candidates usually debate the bigger ideas behind the new financial reforms instead of the fine print.

Wall Street critics said the push is just the latest spin on a continued effort to neuter a rule that the industry has consistently opposed.

“For the industry to say that they’re going to help the regulators understand how they see it and get the rules drafted is nothing but a smokescreen for their strategy to gut, kill and emaciate the Volcker rule,” said Dennis Kelleher, president and CEO of the advocacy group Better Markets.

The five agencies overseeing the rule — the Fed, the Commodity Futures Trading Commission, the Securities and Exchange Commission, the Federal Deposit Insurance Corp. and the Office of the Comptroller of the Currency — must find a way to ferret out illegal “proprietary” trades while not interfering with related trades that keep the markets flowing smoothly for investors.

At a House Financial Services subcommittee hearing last week, regulators admitted their challenges in drawing a bright line between the different types of trades, a problem largely caused by a lack of solid data.

In a 300-page proposal for the rule, regulators at best traced a fuzzy line and asked an extraordinary 1,300 questions for the industry and public to address in comment letters. Due over the next several weeks, the letters could arrive by the thousands. Agency staff members who are drafting the rule then review each comment, checking for form letters before giving a final version to the heads of their agency.

The chairman of the CFTC, Gary Gensler, emphasized at the hearing, “We’re going to be informed by the comments.” And the Federal Reserve remains “open to alternatives,” Fed governor Daniel Tarullo repeatedly explained to the committee members.

Despite their testimony, Rep. Shelley Moore Capito (R-W.Va.), who chairs the Financial Institutions and Consumer Credit subcommittee, doubts that regulators can settle on a clear definition of acceptable trading before a July deadline.

“I had the impression that all the regulators are hopeful that there will be substantive comment letters, which begs the question, can this go forward by July?” Capito told POLITICO. “I have questions about that, given the complicated nature of this Volcker rule.”

She added that Congress should closely monitor all the agencies involved, since she remains skeptical that the five regulating agencies can coordinate with each other.

“It’s almost a ‘who’s on first?’” Capito said.

Needless to say, the financial industry plans to capitalize on the confusion among regulators.

“They’re struggling,” said Ken Bentsen, the former Democratic Texas congressman who’s now executive vice president for public policy at the Securities Industry and Financial Markets Association. “Our comment letter just on proprietary trading will be more than 100 pages.”

Industry comment letters will probably boil down to two related arguments. First, the government should minimize its footprint to avoid stomping on the markets. Secondly, if the Volcker rule gets enforced too ambitiously, banks could stop participating in legal “market-making” trades, unleashing volatile prices for stocks and bonds that could hurt companies and investment funds.

Rob Nichols, president and CEO of the Financial Services Forum, said agencies will be pushed to flesh out more details, given the possible impacts on stock and bond markets worth tens of trillions of dollars.

“It’s important that we have a much better understanding of all the rule’s many implications for the markets, investors and the broader economy before implementation of the rule is seriously contemplated,” he said.

Sit-down meetings on Capitol Hill and with regulators will both precede and follow the letters. On Tuesday, the U.S. Chamber was scheduled to bring corporate treasurers at nonfinancial companies to meetings at the Fed, SEC and CFTC.

Opponents say Wall Street has dramatically overstated its case.

During last week’s hearing, Massachusetts Rep. Barney Frank, the ranking Democrat on the Financial Services Committee, blasted the argument that banks might pull back from their role as market makers, creating a vacuum that could hurt investors or push the practice to firms that face little government scrutiny.

Prodded by Frank, each agency official at the hearing committed to preserving market making.

“The notion that people are going to be scared away,” Frank summarized, “because of an excessive rigidity has no real foundation.”

Studies sponsored by the securities industry association about the potential costs of the rule also took a beating at the hearing. Simon Johnson, an economics professor at the Massachusetts Institute of Technology, slammed a report by consultant Oliver Wyman that the Volcker rule might cost corporate bond investors $90 billion to $315 billion.

“These are massively overstated,” Johnson told the subcommittee, adding the “methodology is deeply flawed” because it doesn’t fully consider how markets could adjust and equates the effect of the Volcker rule to the 2008 financial meltdown that first led to the reforms.

Asked about Johnson’s objections, the association’s Bentsen said, “They’re entitled to their opinion. We’re entitled to ours.”

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