The unintended (and brilliant) legacy of the Volcker Rule
The Federal Reserve this week became the last of five government agencies to sign-off on simplifying the Dodd-Frank Volcker rule. As expected, there was the usual Washington debate on the merits of the rule change. But the Volcker rule’s momentous legacy will have little to do with the limits on speculative proprietary trading it imposed on the banking system in the wake of the 2008 financial crisis. Rather, the rule will be remembered for sparking an enormous investment in sophisticated trading technology that has brought an unprecedented level of transparency, efficiency and cost savings to the American investing public.
In order to understand this impact of the Volcker Rule, it is important to understand its goals and how those goals were achieved. As Harvard Professor John C. Coates explained in his seminal paper “The Volcker Rule as Structural Law,” the goal of the rule was to shake up the Wall Street trading culture. As Paul Volcker himself noted, “The need to restrict proprietary trading is not only, or perhaps most importantly, a matter of the immediate market risks involved. It is the seemingly inevitable implication for the culture of the commercial banking institutions involved.”
The Volcker Rule was meant to change the culture of banks so that proprietary trading would move from the largest banks to independent trading firms. Almost immediately after the rule went into effect, trading firms like mine started receiving dozens and then hundreds of resumes from the best trading minds at the banks. They wanted to trade, and they needed a new place to do so. But a decade ago, small and new proprietary firms like GTS could not offer the salaries or amenities of the large banks. So, we shopped for talent in the one area where we knew we could successfully compete: Technology. We offered the fastest servers, the most advanced quantitative systems and an atmosphere and culture that was conducive and encouraging to technological innovation.
Big bank traders were hesitant to join startups, but eventually they came to understand, appreciate and love our technology culture. Trading technology blossomed as a result of the best and brightest bringing their energy and creativity to technology-forward firms.
Now the small trading firms of a decade ago provide technologically cutting-edge market making services to the broader investing public. The New York Stock Exchange floor, which at one point seemed to be at risk of extinction, has roared back to life as technological innovation allowed floor brokers and market makers to offer ever growing technological options to listed companies and the investing public.
Indeed, the Volcker Rule technology revolution eventually came full circle. As Nanette Byrnes observed in The MIT Technology Review, “At its height back in 2000, the U.S. cash equities trading desk at Goldman Sachs’s New York headquarters employed 600 traders, buying and selling stock on the orders of the investment bank’s large clients. Today there are just two equity traders left.”
Automated trading programs have now taken over the rest of the work, supported by 200 computer engineers, allowing former CEO Lloyd Blankfein to rightfully proclaim in 2017, “We are a technology firm.” Down the street, JPMorgan Chase now touts itself as a technology disrupter, spending $11 billion a year to fuel a team of 50,000 technologists.
The real winners of the technology revolution reside not on Wall Street but on Main Street. For retail investors, the average cost of trading has plummeted more than 50 percent since 2008 through a narrowing of spreads, which is the price difference between a buyer and a seller when negotiating a sale.
Government policy at times has negative unintended consequences, where future outcomes are unanticipated. Ironically, Paul Volcker himself said during the height of the financial crisis, “The most important financial innovation that I have seen in the past 20 years is the automatic teller machine.”
Mr. Volcker, the rule that bears your name has borne benefits and a brilliant legacy far beyond what was anticipated.
Ari Rubenstein is co-founder and CEO of GTS, a Manhattan-based electronic market maker and the largest designated market maker at the New York Stock Exchange.
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