The Volcker Plan and the Politics of Financial Regulatory Reform

The recent announcement of what I'll call the "Volcker Plan" for regulating banks was sandwiched between two major political events: the election of a Republican Senator from Massachusetts and the Supreme Court's decision "deregulating" corporate campaign contributions. The timing of the announcement in relation to the election of the Republican (Scott Bowen) is suspicious: it suggests a desire to change the subject and recapture the populist mandate by attacking the hated banks in a more dramatic fashion than by the proposal for a bank tax that I discussed in my last post. The suggestion that Vice President Biden was a major advocate for the Volcker Plan reinforces the suspicion of a political motivation. He has no background in business, finance, or economics, but is of course an experienced politician. The administration's contention that the plan had been in the work for months and it's just an accident that it was announced the day after the Massachusetts election is hard to believe.

The significance of the Supreme Court decision is that the decision increases the political power of the banks by enabling corporate rather than just individual financing of ads advocating for or against particular candidates in elections. Congressmen may be reluctant to invite an avalanche of negative ads paid for by banks by voting for regulatory measures that might substantially reduce the profitability of banking.

The administration's tough approach creates the following political problem. On the one hand, in continuing the policy of the Bush administration, the administration has been enormously supportive of the banks, and this has enabled some of them to reap large profits despite the depression. On the other hand, it has been criticizing the banks as pigs, with increasing stridency. The more the administration ratchets up its attacks on the banks--escalating from verbal abuse ("fat cat" bankers) to draconian regulation--the more it plays the populist card and, conceivably, distracts the public from the health care donnybrook, but also, the more it retards recovery by distracting bankers and, if tough regulations are instituted, weakening the banks financially and thus discouraging them from increasing their lending. If as a result economic recovery slows, the administration will pay a political price, while if bank regulation flops as health care reform is flopping, the administration will be thought unable to govern effectively.

It is difficult for the administration to rebut charges of being soft on banks because of the continuity not only of policy but also of personnel between the Bush and Obama administrations. The principal theorists of Bush's response to the financial crash were Geithner and Bernanke, and they're still in place. (The third member of Obama's economic troika, Lawrence Summers, is not as prominent publicly as either Geithner or Bernanke.) Geithner is identified in the public mind with hated Wall Street. Bernanke is identified with keeping interest rates way down is encouraging bank speculation (and high profits) just as the Fed was doing (with his support) in the early 2000s. The turn to Volcker is politically adroit, especially in the wake of the increasing skepticism of the Obama administration on the part of independent voters.

In retrospect, from a purely political perspective at least, the administration would have been better off with a different Secretary of the Treasury and a different Federal Reserve Chairman. Not that it could have removed Bernanke; but by deciding to reappoint him, the President in effect ratified Bernanke's policies. Appointing Volcker to succeed Bernanke might have been better from a political standpoint. Volcker is at once a commanding and a reassuring figure, and cannot be accused of being too friendly with hated "Wall Street."

Enough about politics. The Volcker plan deserves careful consideration. It's a shame it was not taken seriously by the administration from the start; the loss of a year is serious, maybe calamitous, because the plan cannot be adopted overnight. Its evaluation, detailed design, and execution will take years.

The plan is being described in some quarters as "the return of Glass-Steagall." The Glass-Steagall Act, passed in the 1930s depression and repealed in 1999, provided that no company could be both a commercial bank and an investment bank. J. P. Morgan's bank had been both; the Act forced its division into Morgan Stanley (investment bank) and J. P. Morgan (commercial bank). The Act did much else besides; and barring commercial banks from engaging in investment banking in the conventional sense of underwriting new issues of securities would not have averted the financial collapse of September 2008. Even before the repeal of Glass-Steagall, moreover, its thrust of separating commercial banking from other financial activities had been blunted by statutory amendments and regulatory (or rather deregulatory) initiatives. It is the spirit rather than the letter of Glass-Steagall that Volcker wants to revive.

Volcker's basic idea is to insulate traditional commercial banking services from risky modern financing practices. Traditional commercial banking services consist of providing a place to park a person's money (a deposit account and safe-deposit box), making mortgage and commercial loans, administering the payments system (essentially, the system whereby a check written on one bank causes an increase in the payee's account in another bank), providing standby (back-up) credit, and buying and selling Treasury securities and other ultra-safe securities. Banks are either local or have local branches, so that they can engage in "relationship" lending--lending based on knowledge of the creditworthiness of particular borrowers, especially individuals and small business. (Big business has other methods of financing besides commercial banks, such as the issuance of bonds or commercial paper, or by drawing on retained earnings.)

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Richard A. Posner

Richard Posner is an author and federal appeals court judge. He has written more than 2500 published judicial opinions and continues to teach at the University of Chicago Law School. More

Richard A. Posner worked for several years in Washington during the Kennedy and Johnson Administrations. He worked for Justice William J. Brennan, Jr, the Solicitor General of the U.S., Thurgood Marshall, and as general counsel of President Johnson's Task Force on Communications Policy. Posner entered law teaching in 1968 at Stanford and became professor of law at the University of Chicago Law School in 1969. He was appointed Judge of the U.S. Court of Appeals for the Seventh Circuit in 1981 and served as Chief Judge from 1993 to 2000. He has written more than 2500 published judicial opinions and continues to teach at the University of Chicago Law School. His academic work has covered a broad range, with particular emphasis on the application of economics to law. His most recent books are How Judges Think (2008), Law and Literature (3d ed. 2009), A Failure of Capitalism: The Crisis of '08 and the Descent into Depression (2009). He has received the Thomas C. Schelling Award for scholarly contributions that have had an impact on public policy from the John F. Kennedy School of Government at Harvard University, and the Henry J. Friendly Medal from the American Law Institute.

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