The Volcker Rules

Sydney M. Williams

Thought of the Day

“The Volcker Rule”

February 17, 2010

Color me grey, or, more accurately, white. Either way, I find sympathy with those interviewed in this morning’s New York Times: “Elders on Wall Street Favor Tight Rein.”

Following a first year with a litany of failed legislation, including a questionable stimulus (questionable in the sense that despite the $787 billion available, only a fraction was spent), healthcare reform that appears DOA, Cap and Trade that fortunately went no where; climate change, now in disrepute, and card check that also, luckily, withered, Mr. Obama has an opportunity to redeem his Presidency. Outside of creating jobs, the most important legislation that can be passed is financial and tax reform.

On January 21, the President introduced the “Volcker Rule” when he proposed tightening regulation on banks, the key component of which would preclude deposit gathering institutions from engaging in proprietary trading and investing in hedge funds or private equity funds. The proposals would also limit consolidation within the industry.

As would be expected, the proposals were received with less than enthusiasm by most on the Street. Critics praised Mr. Volcker as they damned him; expressions of “having great respect for Mr. Volcker” were always accompanied with a “but”.

Complaints that it would be difficult to distinguish between trades done to accommodate a client or for legitimate hedging purposes, and those done solely for the benefit of the bank may be valid, but appear self-serving.

Financial reform should include reducing leverage; increased transparency, including full disclosure of off-balance sheet items; reforming credit agencies, so that they are hired by a third party, not the issuer. It should include, as former Treasury Secretary Henry Paulson wrote in an op-ed in yesterday’s New York Times, a systemic risk regulator to monitor the stability of markets and a resolution authority to impose an orderly liquidation of any failing institution. The owners of failing firms should not be bailed out with tax payer’s money. Given my belief that people should be responsible for their own actions, a consumer protection board seems, to me, redundant and unnecessary.

But the problems of the last few years reflect a broader cultural problem, the need for instant gratification. The sense of investing, of looking toward the longer term, needs to be restored. The tax code can be used to encourage such behavior. This need for instant rewards is broad spread. It drove people in the naughts to buy homes to flip. Today it funds state treasuries with millions from lotteries. It is seen in the increase in frivolous lawsuits. It is a problem embedded in our culture that will be difficult to eradicate, but sophisticated behavioral economics should be able to provide ways to encourage the concept of looking further ahead. There is an imperfect circularity to life. The concept of let’s eat and drink today for tomorrow we die was first expressed in Corinthians 2000 years ago. However, societies and cultures have changed and will change. A society that invests for the future is better prepared for that future.

Rules and regulations, clearly understood and properly enforced, have never impeded Wall Street. It is uncertainty that concerns the Street. I agree with those elderly sages and their concerns of cowboy capitalism, with its emphasis on immediate rewards, which imperiled both Wall Street and Main Street in the fall of 2008. Should Mr. Obama put aside misguided liberal policies, focus on Congress passing financial and tax reform that encourages long term investing, he will redeem his Presidency and the Country will be the beneficiary.