The Volcker Rule: Let’s get it right

As with so many things that involve the government, good intentions do not necessarily lead to good results. This is certainly true of the proposed Volcker Rule.

Paul Volcker, who was chairman of the Federal Reserve from 1979 to 1987, is one of the most significant figures of the last quarter of the 20th century, and his legacy remains strong today.

After the near-financial collapse in 2008, he made one of his most important points when he suggested it is totally inappropriate for banks to use deposits insured by the American taxpayer to make speculative investments.

This idea became known as the Volcker Rule, and was in theory included in the Dodd-Frank law. It is a rule that makes sense.

The problem is that, as interpreted and propounded by the regulatory agencies implementing Dodd-Frank, it looks a lot more like a camel than the horse it was designed to be.

As currently proposed, the “Volcker As Adjusted” rule only marginally accomplishes its original goals while creating a great deal of unnecessary and counterproductive reaction in the financial markets.

It will complicate market-making by American financial houses — making it excessively restrictive and bureaucratic — and thus significantly reduce liquidity in the marketplace and the ability of U.S. companies to compete and create jobs on Main Street. This was not the goal, but it will be the outcome if the federal bureaucracy continues on its current course.

The topic Volcker originally tried to address was keeping banks from using funds insured by the taxpayer to take risks for which the taxpayer would be liable if the deals went bad.

The easy way to correct this would have been to return to a time when commercial lending banks and financial houses were separate, to have created a new and revamped 21st century Glass-Steagall structure.

Instead, Dodd-Frank asked federal regulators to do the contradictory and impossible tasks of designing a regime wherein market-makers can give businesses the support they need to take on risk while denying them the resources they need to do it effectively and safely.

Implementing this law as currently interpreted is the regulatory equivalent of putting a square peg in a round hole. It cannot be done in a way that fulfills the needs of business and markets or allows for the liquidity required to move the economy forward in a robust way.

In addition, the proposed rule, rather than reducing risk, most likely will push that risk into other, even more opaque, places. The Japanese and Canadian governments, and now even the British, have said the proposal aggravates the risks for their markets.

According to the Canadian Office of the Superintendent of Financial Institutions, “OSFI is concerned that the draft regulations may have the unintended consequence of significantly impeding Canadian and other foreign financial institutions’ ability to manage their risk … which could give rise to prudential concerns in Canada and abroad.”

It is not only that “Volcker As Adjusted” gums up our ability to provide liquidity to our American employers it also appears that the proposed rule will undermine a number of our best allies and trading partners’ economies, and create risk for them they neither want nor expected.

It is possible this can be sorted out. Unfortunately, it is more likely that the sorting-out process will cause massive, unintended consequences and will disrupt economic growth as it winds its way through a new labyrinth of confusing regulations and corporate restructuring.

The bottom line will be that, rather than reducing system risk and potential taxpayer liability, both will increase — if not overtly, certainly through the indirect consequences of the confusion in the market and the instability that will result.

It is up to Congress to reenter the picture and take another run at this by giving the regulatory agencies some additional flexibility and direction without going through the uncertainty of creating a brand new law.

This can be done by continuing the hearing process and bringing in all the parties who might be affected, including our trading partners. That would give everyone an opportunity to lay out better ideas than those that have been proposed by the initial rule.

A great deal has been learned in the last year about the limitations of doing this in the ad hoc manner that has proceeded to date.  A much better way to do this would be to return to the original intent of the rule, look at the history of the separation of banking and financial houses and the evolution of the availability and creation of credit and liquidity, and determine a cleaner and more orderly way to accomplish the purposes of Volcker.

Judd Gregg is a former governor and three-term senator from New Hampshire who served as chairman and ranking member of the Senate Budget Committee and as ranking member of the Senate Appropriations subcommittee on Foreign Operations. He also is an international adviser to Goldman Sachs.