Exceptions to the Volcker Rule

Members of Congress aren't the only ones working hard on the financial regulation effort. Banking industry lobbyists are also striving to create loopholes in new regulations that would endanger the profits of of the firms they represent. The Volcker Rule, which would prohibit proprietary trading, is one of the biggest targets they're aiming at. While this probably shouldn't come as a shock to anyone, it has many financial reform advocates unhappy. But could these loopholes do more good than harm?

The New York Times reports on these efforts, some of which we've actually known about for more than a month:

To secure the support needed for their bill, Senate negotiators are leaning toward creating a series of exemptions to the Volcker Rule that would allow banks to continue to operate these businesses as investment funds that hold only client money, according to several Congressional aides, industry officials and lawyers.

The three main changes under consideration would be a carve-out to exclude asset management and insurance companies outright, an exemption that would allow banks to continue to invest in hedge funds and private equity firms, and a long delay that would give banks up to seven years to enact the changes.

The spirit of the Volcker Rule is to prevent banks from investing their own money in risky endeavors, which could endanger customer accounts. But that end wouldn't be harmed through these loopholes. The financial companies would be able to continue to engage in trading activities, but those would be limited to using clients' money.

Let's consider each loophole separately:

Insurance & Asset Management

It's kind of hard to imagine these firms not engaging in trading activities. Investing has long been a major function each business. For example, without the ability to derive investment income, insurance premiums would rise, which probably won't draw many cheers from consumers. So long as we're talking about these firms investing customers' money at their own request, it's hard to see how this conflicts with the spirit of the Volcker Rule

Hedge Funds & Private Equity

Again, if these investments are at clinets' request, where's the problem? Even if the investments do poorly, the customers tied to those investments will lose money. The bank, and its retail customers, will be unharmed. And besides, hedge funds and private equity firms did not play a significant role in causing the financial crisis.

Long Delay

If this rule is a major shock to the industry, and financial reform advocates are certainly hoping it is, then allowing ample time for adjustment seems perfectly reasonable. As noted here, when you deprive banks from one source of income, they need to find a way to make it up elsewhere. A prohibition on proprietary trading will result in banks needing to restructure their strategies. For the good of financial stability, it's best if this transition is a gradual one.

Whether you agree with the spirit of the Volcker Rule or not, it's hard to see how these exclusions cause any harm to financial stability. Instead, they would help to cushion the blow that the industry will feel. That's for the best, since a healthy banking sector benefits everyone.