Really, the Senate's Volcker Rule Isn't Much Stronger Than the House's Version

There's some broad misunderstanding among a number of news outlets about some of the provisions in financial reform. That's not entirely surprising, because these are huge, complicated bills. But major media outfits should try to get the big issues right. Numerous outlets continue to report that the Senate has a strong provision of the so-called Volcker Rule, which would prevent banks from proprietary trading, while the House bill doesn't contain any version. This isn't right.

First, the Senate's bill (.pdf) only sort of creates a proprietary trading ban. It says (in section 619):

Subject to the recommendations and modifications of the Council under subsection (g), and except as provided in paragraph (2) or (3), the appropriate Federal banking agencies shall, through a rulemaking under subsection (g), jointly prohibit proprietary trading by an insured depository institution, a company that controls, directly or indirectly, an insured depository institution or is treated as a bank holding company for purposes of the Bank Holding Company Act of 1956 (12 U.S.C. 1841 et seq.), and any subsidiary of such institution or company.

So yes, proprietary trading will be banned, subject to subsection (g). And that subsection says that the new Council of regulators will do a study to make sure that institutions are safer without prop trading and the ban doesn't cause the cost of credit to increase, among other things. So this isn't a slam dunk. If the Council decides that banning prop trading will harm banks and credit, then it will nullify the provision.

Moreover, despite what new outlets are saying, the House's bill (.pdf) actually does contain a provision that could do much the same thing. It says (in section 1117):

If the Board determines that propriety trading by a financial holding company subject to stricter standards poses an existing or foreseeable threat to the safety and soundness of such company or to the financial stability of the United States, the Board may prohibit such company from engaging in propriety trading.

Interestingly, the House version preceded the Obama administration championing the proposal and giving it the nickname of the Volcker Rule. It's different than the Senate's proposal for two main reasons. First, it doesn't call for a blanket ban, but allows regulator discretion over which firms should not be allowed to engage in proprietary trading. Second, it gives the power to the Federal Reserve Board to determine which firms to ban from proprietary trading, instead of giving the Council this responsibility.

So which provision is stronger? It could go either way. The Senate's version calls for a blanket band, which might seem stronger. But the diverse group of regulators sitting on the Council must still consent -- after doing an extensive study. The House version, however, gives the Fed more power to forbid whatever large firms it pleases from prop trading, without a study.

Ultimately, it depends on the view of the Fed versus that of the Council. Opponents of the House version who favor the Volcker rule might complain that the Fed won't ban big banks from prop trading, so the provision is useless. Of course, the same complaint could be made about the Senate version, if you believe the Council will ultimately decide not to enact the ban after its study.

But it should be clear that each bill sort of calls for a ban on prop trading in its own way. They just disagree on how it should be done. That will have to be ironed out during the conference process. Expect to see something in between the House and Senate version, which would specifically exclude insurance companies and allow banks to continue to offer asset management to clients. House Financial Services Committee Chairman Barney Frank (D-MA) has already promised he will fight for these exclusions. The way the House bill is written, these exclusions would already exist.