The House Financial Services Committee dedicated its last hearing of this Congress to a contentious examination of the pending regulations under the Dodd-Frank Act, including the Volcker Rule, which is supposed to prevent the largest, “too big to fail” banks from engaging in trading for their own account, known as proprietary trading, with depositors’ funds, given that these institutions are supported by the federal safety net. Exceptions are provided in the statute for market making and for hedging activities that reduce risk.
The five financial regulators have been sorting through thousands of comments, but Federal Reserve Chairman Ben Bernanke told a press conference that the rule would be finished during the early months of 2013. The Wall Street Journal has reported that outgoing Securities and Exchange Commission Chairwoman Mary Schapiro is pushing for an early resolution of the issues entailed by this regulation.
The hearing had emotional overtones, not only because of the intensity of the views of the committee members and witnesses, but also because it was the last hearing for Rep. Barney Frank, D-Mass., former chairman of the committee and co-author of Dodd-Frank Act who is retiring from Congress, and Rep. Spencer Bachus, R-Ala., who has been timed out as chairman and will be succeeded in the next Congress by Rep. Jeb Hensarling, R-Texas.
Although the Volcker Rule directly targets only a handful of banks, they dominate the banking industry and represent a significant proportion of trading activity in one capacity or another. They have worked diligently to mobilize groups representing their customers in the United States and abroad to call for relief from, delay of and even repeal of the provision of Dodd-Frank that authorizes the rule.
The overriding complaint is that the Volcker Rule is difficult to comply with because it is difficult to determine, on a trade-by-trade basis, which activities are proprietary and which are not.
Defenders of the rule have responded in other forums that the very complexity of which the banks complain is there because Congress wanted to accommodate the demands of banks to be allowed to continue to engage in activities that arguably are beneficial to customers and markets.
Proponents of the rule argue that while it was under consideration that the financial system would be safer if banks got out of this business and other firms took it over, the banks prevailed and now they complain that the rules will be difficult to administer.
Among the panelists, four supported the bank position, and two opposed it. However, all of the testimony had an argumentative edge, although they differed in their specific recommendations for fixing the problems with the rule that they identified.
James Barth of Auburn University presented the standard industry critique that the Volcker Rule is directed at activities that did not contribute to the financial crisis of 2008 and 2009, but that the regulation will have unintended consequences that will raise costs to investors and to companies that use the capital markets to finance themselves and to manage their own risks. He presented statistics showing that where losses of $1 billion or more have occurred in specific trades, with the exception of hedge funds, the entities that incurred the losses had more than adequate capital to absorb them.
Regarding recommendations for relief, Jeff Plunkett, general counsel and executive vice president of Natixis Global Asset Management, spoke on behalf of the Association of Institutional Investors and called for greater clarity to ensure that regulators focus on activities that do not benefit customers; that the definition of “near-term” be clarified across markets where the definition differs, depending on how liquid a market is; and that mutual funds not be swept into the categories of hedge funds or private equity funds and subjected to additional regulations. He suggested that a technical corrections bill would be the appropriate legislative vehicle to address these issues.
Thomas Quaadman, vice president of the Chamber of Commerce’s Center of Capital Markets Competitiveness, suggested that the regulations should be subjected to further study before they are implemented.
Paul Schott Stevens, CEO of The Investment Company Institute, urged that the regulations be recalled, and if the regulatory process does not resolve industry complaints, Congress should enact new legislation.
The supporters of the proposed rule were William Hambrecht, who represented a task force of the CFA Institute and the Council of Individual Investors, and Dennis Kelleher, CEO of Better Markets.
Both Hambrecht and Kelleher stressed that the reason the Volcker Rule is needed is to reduce the risk in the financial system due to trading activities that are conducted with depositors’ funds by firms backed by the federal safety net. They also took issue with the idea that distinguishing proprietary trading from other activities is as difficult as the industry claims it is.
Hambrecht reported that the task force members determined that the cause of the risk is the extraordinary leverage that banks have been able to apply, due in part to the opacity of their balance sheets. Kelleher singled out the “London Whale” trade by JPMorgan Chase, and he warned that the cost to the economy of the crisis of 2008 and 2009 would be at least $12.8 trillion.
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