Paulson Appeals To Reason In Criticizing Volcker Rule

Former Treasury Secretary Hank Paulson has an op-ed in the New York Times today. In it, he argues that the Obama administration's proposal to ban banks from proprietary trading should be abandoned. The so-called Volcker rule is already having trouble in the Senate, so Paulson will likely get his wish. But interestingly, it doesn't look like he's against the proposal in totality, just the part about banning prop trading. Meanwhile, he favors many of the less-controversial reform measures the House passed.

Here's the money quote from the op-ed:

The debate recently has centered on big banks and trading risks. I agree that big banks do pose a dangerously large risk to our financial system, and I am troubled that concentration in the industry has only increased since the crisis. But if we are to protect our system from falling into trouble again, we need broad-based reform that covers all types of financial institutions and all forms of potentially risky activities.

For example, the most recent proposal by the Obama administration -- to bar big banks from trading driven by other than customer-related activity -- would not have prevented the collapse of Fannie Mae, Freddie Mac, Lehman Brothers, American International Group, Washington Mutual, Wachovia or other institutions whose failure contributed to the crisis. Rather than dictating a set of rules that will become out of date as the markets evolve, policy makers should devise legislation that ensures that regulators have the authority to tackle the issue of size and all potential systemic risks.

Paulson is correct. Although prop trading sounds like a risky, scary endeavor to those who don't understand it, the practice didn't cause the financial crisis. Some causes of the crisis included poor systemic risk oversight, insufficient capital requirements, and the lack of a non-bank resolution authority. Paulson goes on to argue in favor of all of those. While prop trading might be a fun populist punching bag, it's really inconsequential insofar as systemic risk is concerned.

And, in fact, Paulson doesn't appear to object to everything that the Obama administration proposed along with the Volcker rule. As I've mentioned in the past, the second part of the administration's plan is to limit banks' liability concentrations. I don't see Paulson objecting to this. And since he appears to worry greatly about systemic risk, I don't think he would. I also suspect he would agree that a better way of controlling banks from engaging in systemically risky behavior would be to make sure they use less leverage. Then prop trading would be effectively limited, along with other potentially dangerous bets or practices.

I find Paulson's op-ed utterly reasonable. He doesn't want the important legislation to get hung up on a controversial rule that won't do anything to prevent another financial crisis anyway. Instead, he understands that Washington should focus on what it knows can help.

I would add: if Democrats can reach a consensus in favor of something like the Volcker rule, then it should feel free to do so -- after the more important priorities have been first put in place. I'm not in favor of it, but if a large portion of lawmakers in Washington are, then that's their prerogative. I just don't want them to let it stand in the way of other less controversial, very necessary reforms, which they've already taken too long to put in place.