Volcker on the Volcker rule

Paul Volcker's written testimony to the Senate Banking Committee yesterday put the Volcker rule in a clearer perspective. The theatricality of Obama's earlier announcement - not to mention its vagueness (as yet unresolved) and populist spin - led a lot of observers to think that the White House was advocating a return to Glass-Steagall as the cornerstone of its approach to financial regulation, or at least as one of its most critical components. I thought Volcker tried to correct that impression.

[T]he first point I want to emphasize is that the proposed restrictions should be understood as a part of the broader effort for structural reform...

The first line of defense, along the lines of Administration proposals and the provisions in the Bill passed by the House last year, must be authority to regulate certain characteristics of systemically important non-bank financial institutions. The essential need is to guard against excessive leverage and to insist upon adequate capital and liquidity.

It is critically important that those institutions, its managers and its creditors, do not assume a public rescue will be forthcoming in time of pressure. To make that credible, there is a clear need for a new "resolution authority", an approach recommended by the Administration last year and included in the House bill.

If that focus on better regulation of non-banks can be maintained, then I have no strong feelings one way or the other about Volcker's proposed restrictions on deposit-taking banks. Whether they make sense will depend on the details and the implementation. I note, by the way, that Volcker seems to envisage plenty of regulatory discretion:

Most of those institutions [big commercial banks doing proprietary trades] and many others are engaged in meeting customer needs to buy or sell securities: stocks or bonds, derivatives, various commodities or other investments. Those activities may involve taking temporary positions. In the process, there will be temptations to speculate by aggressive, highly remunerated traders.

Given strong legislative direction, bank supervisors should be able to appraise the nature of those trading activities and contain excesses. An analysis of volume relative to customer relationships and of the relative volatility of gains and losses would go a long way toward informing such judgments. For instance, patterns of exceptionally large gains and losses over a period of time in the "trading book" should raise an examiner's eyebrows. Persisting over time, the result should be not just raised eyebrows but substantially raised capital requirements.

Well, well. So much for simple rules and clear-cut prohibitions. When the regulator judges it appropriate, raise capital requirements!

So long as the rest of the agenda is not forgotten, fine. My worry has been that the Volcker rule will be a distraction from what the great man himself calls the first line of defense: more demanding capital requirements, liquidity requirements, leverage caps and early resolution authority for all systemically important financial institutions. Distraction and delay are still the risk, I think: see these FT and NYT reports. But I am glad that Volcker, at any rate, does not see his commercial-banking rule as any kind of substitute for those other measures.

We seem to agree on the main thing, after all. Which is good. I hate disagreeing with Volcker.