Five U.S. agencies will finish the Volcker rule tomorrow after more than three years of Wall Street resistance to its limits on trading and investing. Lawmakers and their allies who want to rein in big banks are ready to pounce if it isn’t strict enough.
Politicians and advocates—some Democrats, some Republicans—who blame the 2008 financial crisis on deregulation express concern that the Volcker rule won’t adequately block banks from making risky bets with their own money. If the rule is too weak, they say, it will add fuel to a push to reinstate a Depression-era law known as Glass-Steagall that split banks and securities firms until 1999.
Such vows suggest U.S. lenders planning to challenge the ban in court risk a political backlash. A 2011 draft of the rule, required by the Dodd-Frank Act at the urging of former Federal Reserve chairman Paul Volcker, disappointed some politicians and organizations that wanted a stronger ban. Lawmakers already have drafted legislation.
“If people aren’t satisfied with the implementation of this thing, that’ll redouble the pressure to go back and look for something else,” Marcus Stanley, policy director for Americans for Financial Reform, an umbrella group of more than 250 organizations pushing for stronger restrictions on Wall Street. “The Volcker rule was the major thing that said that these guys just crashed the world economy and we’re going to ban something.”
The rule aims to reduce the chances that banks will put federally insured depositors’ money at risk by banning proprietary trading. The Dodd-Frank Act proposed limited exemptions on the ban for some hedging and market-making trades. The debate since has focused on how those exemptions should be defined.
“The basic point is that there has been, and remains, a strong public interest in providing a ‘safety net’—in particular, deposit insurance and the provision of liquidity in emergencies—for commercial banks carrying out essential services,” Volcker, 86, said in testimony to Congress in 2010. “There is not, however, a similar rationale for public funds, taxpayer funds, protecting and supporting essentially proprietary and speculative activities.”
Banks including Goldman Sachs Group Inc., JPMorgan Chase & Co., and Morgan Stanley have argued that the Volcker rule is too broad, poorly defined, and could restrict credit and increase costs for their clients.
“If regulators curtail all proprietary trading in the U.S. banking system, I worry about the unintended consequences in terms of the ability of the financial markets to have sufficient liquidity to function properly,” William Isaac, a former chairman of the Federal Deposit Insurance Corp. (FDIC) who now oversees Fifth Third Bancorp, said in an interview. “This is particularly worrisome at a time when the economy in the U.S. continues to limp along and in Europe appears to be sliding back into recession.”
For their part, anti-Wall Street activists have lobbied for the opposite, to force banks to act more like a public utility and curb profit-seeking speculation.
“Philosophically, what we would like to see is the return to Glass-Steagall,” said Bartlett Naylor, a lobbyist for Public Citizen. “When it came to Dodd-Frank, the closest we got was this.”
The term Glass-Steagall usually refers to several provisions of the 1933 Banking Act that barred commercial banks from owning affiliates that underwrite and trade securities. The law included other measures to restore faith in the Depression-shattered banking system, including founding the FDIC to protect customers’ savings in the event of a bank failure.
In 1999, Congress passed a deregulation law known as the Gramm-Leach-Bliley Act that repealed the parts of Glass-Steagall which built a firewall between investment and commercial banking.
During the congressional debate over Dodd-Frank, President Barack Obama and his administration argued that simply restoring Glass-Steagall was an imperfect response to the financial crisis. They noted that the most troubled investments of the largest banks came through mortgage lending, not trading.
“A huge amount of risk built up outside our banking system, outside the safeguards and protections we put in place in the Great Depression,” Timothy Geithner, who headed the Federal Reserve Bank of New York during the crisis and served as Obama’s first Treasury secretary, said last year in remarks to the Commonwealth Club in San Francisco. “That risk and leverage grew up, built up, very substantially, and when the storm hit, it put enormous pressure on a part of the system that provided about half the credit to the American economy. Nothing to do with Glass-Steagall.”
In the Volcker rule, the administration and Glass-Steagall fans found an issue they could get behind, even while they clashed over its details.
“It really took on a symbolic importance,” said Michael Barr, a former Treasury Department official who led the administration’s push on Dodd-Frank. Barr, now a professor at the University of Michigan, said the embrace by the advocates was crucial to its inclusion in the law.
The view that deregulation of the financial industry in the 1990s was a prime cause of the 2008 crisis resonates with both Democrats and Republicans, and many of their proposed remedies have drawn support in both parties. One measure, championed by Senator Elizabeth Warren, a Massachusetts Democrat, and Senator John McCain, an Arizona Republican, is named the “21st Century Glass-Steagall Act” and aims to separate “traditional banks from riskier financial services.”
“We should not accept a financial system that allows the biggest banks to emerge from a crisis in record-setting shape while ordinary Americans continue to struggle,” Warren said in a September speech marking the fifth anniversary of the turmoil. “And we should not accept a regulatory system that is so besieged by lobbyists for the big banks that it takes years to deliver rules, and then the rules that are delivered are often watered-down and ineffective.”
Another proposal, sponsored by Senators Sherrod Brown, an Ohio Democrat, and David Vitter, a Louisiana Republican, aims at the problem of large-scale bank failures without restoring Glass-Steagall. Instead, Brown and Vitter propose curbing the size of large banks by imposing a 15 percent capital requirement on them.
“It is premature for anyone to take a victory lap when ‘too-big-to-fail’ policies are still alive and well,” Brown said in a statement last week. “Despite what some on Wall Street and in Washington may say, our work is not finished.”
It’s not just lawmakers and policy groups who favor a new Glass-Steagall; the idea has support from some Wall Street veterans, too. Sanford “Sandy” Weill, whose creation of Citigroup Inc. ushered in the era of U.S. bank conglomerates in the 1990s, has said ending Glass-Steagall’s prohibitions was a mistake.
“What we should probably do is go and split up investment banking from banking,” Weill said in a 2012 interview on CNBC. “Have banks do something that’s not going to risk the taxpayer dollars, that’s not going to be too-big-to-fail.”
Douglas Elliott, a former investment banker who is now a fellow at the Brookings Institution research group in Washington, said that in the years since Dodd-Frank was enacted, the Volcker rule has taken on outsized importance to anti-Wall Street activists.
“There seems to be this feeling that cutting off proprietary trading eliminates all of the bad stuff on Wall Street,” Elliott said in an interview. “I’m puzzled as to why so many chips have been placed on this rather than other issues progressives care about on financial reform.”
Regulators released their first version of the Volcker rule in 2011, which made an attempt to define the two kinds of trades Congress said should be permitted: hedging and market-making. Those who wanted tougher curbs got a boost in early 2012 when New York-based JPMorgan acknowledged botched derivatives bets that eventually caused more than $6.2 billion in losses.
Glass-Steagall advocates including Naylor of Public Citizen recognize the irony that the best argument for their side came from one of the banks fighting it. They have intensified their lobbying in the homestretch.
“If the Volcker rule comes out weak, then we’re going to go all-in on getting even more ambitious financial reform,” Naylor said.
While the Obama administration hasn’t endorsed a Glass-Steagall 2.0, it has signaled willingness to consider additional action if the current regulatory structure is deemed inadequate.
“Earlier this year, I said if we could not with a straight face say we ended ‘too-big-to-fail,’ we would have to look at other options,” Treasury Secretary Jacob J. Lew said in a speech last week in Washington. “Based on the totality of reforms we are putting in place, I believe we will meet that test, but to be clear, there is no precise point at which you can prove with certainty that we have done enough. If, in the future, we need to take further action, we will not hesitate.”