Volcker Rule will hurt big banks without making them safer.
The Volcker Rule is bad policy with good intentions. Because it is bad policy, regulators should tread lightly, designing and applying the new rule so as to minimize the damage.
OUR VIEW: Banks need the Volcker Rule
There are three major flaws in the analysis supporting the Volcker Rule:
- For starters, the rule is often oversold as being a way to prevent financial crises like we just had. However, proprietary trading — the focus of the rule — had almost nothing to do with the big crisis of 2007-09. Maybe a future crisis would be different, but we should be deeply suspicious of that argument, given how little proprietary trading was connected with this far-ranging one.
- Further, the rule is said to reduce the risk banks will choose to take. Instead, it will cause banks to shift where they take their risks. Banks will choose the risk level with which they are comfortable, with the total level unaffected by whether proprietary trading is allowed.
Banks take risks in many different areas. Lending itself, banks' core activity, can be very risky, as we just saw with the subprime mortgage crisis and a host of past banking crises. We also want banks to own securities as liquid investments, which is why we are pushing them to hold more through other regulations. These investments carry risks, too. Small banks lost big money on their loans and investments in the last crisis without engaging in any proprietary trading.
- Worst, the rule will do considerable harm while failing to make banks safer. Banks and their affiliates play very important roles in making American financial markets the most efficient in the world. They do this in large part by standing ready to buy and sell securities at a good price. To do this, it is essential that they be allowed to hold inventories of securities, just as a car dealer owns cars.
There is simply no good way to separate "proprietary trading" from this kind of market-making activity, or indeed from some other activities we want and need banks to do.
The Volcker Rule will end up discouraging market making, leading to less efficient markets; higher borrowing costs for businesses, families and governments; and creating losses for pension funds, families and others who currently own bonds directly or through mutual funds.
Douglas J. Elliott, a former investment banker at J.P. Morgan and other institutions, is now a fellow in economics at the Brookings Institution in Washington, D.C.