Select Page

Public Policy behind Sec. 619

The public policy behind the Volcker Rule is fairly apparent.  As the Chairman of the Federal Reserve from 1979-87, Paul Volcker (and the rule that bears his name) seeks a nostalgic return to a time when he was directing US monetary policy – specifically, a time before the Gramm-Leach-Bliley Act (“GLB”).  GLB was passed in 1999 primarily as a means to repeal the restrictive provisions of the Banking Act of 1933 (known as the Glass-Steagall Act), which imposed anti-speculation provisions separating Wall Street investment banks from depository institutions.

The logic behind Glass-Steagall was that because depository institutions are so important to a large majority of Americans (i.e., they hold everyone’s money) we don’t need to subject them to further peril via pro-risk investment banks.  If the risky bets went poorly, those bank deposits would be insured by the Federal Deposit Insurance Corporation (“FDIC”), but the government would then be burdened by the cost of replacing these insured funds via the FDIC.   The combination of investment banking and depository institutions can also lead to conflicts of interest between the depository banks’ management and the customers whose deposits they hold.  Its repeal, via GLB, was supported by the premise that many international banking institutions did not have such legislative separation requirements, and therefore the premise that this separation would work in practice, was sound.  Additionally, increased international competition called for a leveling of the playing field between US banks and their international rivals.

However, in leveling that playing field and allowing the banks to compete with their international rivals (since GLB in 1999) many banks immediately grew to previously unseen, behemoth proportions and some eventually became “too big to fail”. Id.  This is another crux of the Volcker rule’s policy as a whole.  By limiting bank growth via these restrictions, we won’t have to combat “too big to fail” again in the future.  Id.  

While the policy behind this objective is sound, the methodology behind it is over-reaching or, at best, inaccurate.  That is, the most recent financial crisis was in no large part the result of the items addressed by section 619.  Commercial paper did not dry up because of proprietary trading, nor was bad consumer mortgage debt securitized and tranched through sponsorship of hedge or private equity funds by banking entities.  While neither Paul Volcker nor the drafters of the bill specifically claim that to be the case, the rule’s sweeping changes which bring the US financial system back to a pre-GBL era are an equally excessive response to the minimal role played in the financial crisis by the acts this rule prohibits.  What, then, could be the reason for such expansive regulatory responses (such as section 619) if they are not geared at correcting the wrongs at issue in the crisis?

To solve this query, one needs to look no further than a simple textual analysis – not of the Act, but the rhetoric that birthed it.  In January 2010, when President Obama indicated that the motives behind his upcoming financial reform initiative were to prevent another “binge of irresponsibility” and “reckless risks in pursuit of quick profits and massive bonuses” he hinted that the motives behind this legislation might be political in nature.  Not party politics, but political in that they were aimed at directing the focus of public economic displeasure away from the government (and specifically his administration) toward the greedy group that was even less popular than the government: Wall Street.

The bottom line is, if this rule is not the pseudo-punitive, anti-Wall Street attack that Martin Wolf, and others, claim, then its hard to justify its existence at all – as its construction hides an inherent flaw which decimates the premise of its main purpose.  Id. That is, because the Volcker Rule only applies to depository institutions, it would be no massive feat for the likes of Goldman Sachs and Morgan Stanley to simply return their small deposit base(s) and evade the rule altogether.  This leaves only true depository institutions as subject to the Rule – and unnecessarily so, as those institutions are already regulated by the FDIC.  So, if FDIC loss-prevention (an therefore, government cost-savings) is the goal of this rule (as it was in Glass-Steagall), that goal is subsumed by the massive expense of this Act as a whole.  The entire exercise becomes, therefore, moot – like a coda to reemphasize the Act’s recurring theme of expensive redundancy