Over at the Conglomerate, David Zaring has a nice post on the dueling commentaries surrounding the Volcker rule. Some sources insist that the rule is useless due to hopeless complexity and vagueness. Others contend that the rule seriously hampers banks’ bottom line. Indeed, many banking industry members contend that the Volcker rule, unless narrowly interpreted and enforced, threatens the viability, not only of banking entities, but also of trading markets more generally. David correctly highlights one of the impediments to any real understanding of the trade-offs confronting regulators on Volcker rule implementation – the issues are so complex and numerous, and the rhetoric has become so overblown, that it’s difficult to get any real sense of the challenges confronting rule implementation and enforcement.
But I think David misses the mark when he points to structural changes at banks as evidence of the Volcker rule’s effectiveness:
And all the indicia, literally all of them - that investment banks are losing money, planning layoffs, and spinning off prop trading at the same time - suggest that regulatory reform, rather than being ignored, is substantially affecting the organization of financial intermediaries.
But a rule that merely affects financial intermediary organizational structure is not the same thing as a rule that successfully inhibits prop trading. As I discuss at length here, in anticipation of the Volcker rule, a number of affected banking entities have shut down or announced an intention to shut down their stand-alone proprietary trading desks. According to news reports, some of those traders have been relocated to other parts of firms’ trading operations.
The key point here is that stand-alone proprietary trading activity accounts for a relatively small amount of banking entity revenues, probably around three percent. To avoid an easy end-run around the Volcker rule’s restrictions, federal regulators will have to police trading that takes place outside of designated proprietary trading desks -- for example, trading in connection with market making, underwriting, hedging, and customer service. In other words, the battle lines are not over prop trading desks. What matters is how federal agencies will ultimately define the exemptions to the proprietary trading ban, and then police trading activity to distinguish permitted trades that constitute market making or trading on behalf of customers from prohibited proprietary trading activity.
In addition, Steven Davidoff’s contention that the Volcker Rule “may have the unintended effect of dividing the world back into investment banks and commercial banks” is, in my view, mistaken. This roundabout return to Glass-Steagall was precisely the intention of many Volcker rule adherents, including, according to some sources, Paul Volcker himself. (A point I discuss here). Whether that result is good or bad is, of course, open to much debate. But it’s hard to claim this potential result was unforeseen.