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Volcker Responds To Volcker Rule Critics

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Former Fed Chairman Paul Volcker
Former Fed Chairman Paul Volcker

Paul Volcker has two words for the people who say the new banking-sector rule that bears his name is going to wreak havoc on the financial system: "Not so."

The former Federal Reserve chairman on Monday submitted a long response to critics of the so-called Volcker Rule, the controversial section of the Dodd-Frank financial-reform act that prohibits banks from trading with their own money. The goal of the rule is to help keep the Too Big to Fail set from taking on so many big risks that they blow up the global economy. Again.

Monday was the last day for banks, economists, investors and other observers to tell the government what they think about the Volcker Rule. There have been plenty of pro-Volcker comments, but lots of anti-Volcker comments, too.

The arguments of the anti-Volcker set fall into four broad categories, according to Volcker:

First, that big risks to the financial system aren't being created by commercial banks trading with their own money, also known as "proprietary" trading.

Second, that trading in some markets, like municipal bonds, will become more difficult, possibly raising costs for investors.

Third, that U.S. commercial banks won't be able to compete as well with foreign banks.

And fourth, that "the proposed regulation is simply too complicated and costly."

"My short answer to each of these objections is: 'not so,'" Volcker wrote.

Here's the anti-Volcker argument, and Volcker's response, to each:

About the first argument, that proprietary trading by commercial banks is not really all that risky, Volcker says that's pure hogwash. All one has to do is look at the global financial crisis of 2008 to see the evidence.

"The recent years of financial crisis have seen spectacular trading losses in large commercial and investment banks here and abroad operating on an international scale," Volcker wrote, "with various loss estimates for major international commercial and investment banks ranging to hundreds of billions of dollars."

He also says that the risks of proprietary trading include more than the destruction of the global economy. It also creates a pernicious culture of greed that puts profit ahead of customers.

"Can one group of employees be so richly rewarded, the traders, for essentially speculative, impersonal, short-term trading activities while professional commercial bankers providing essential commercial banking services to customers, and properly imbued with fiduciary values, be confined to a much more modest structure of compensation?" Volcker asks. "The result is to undermine the financial services industry as a service industry."

Volcker doesn't take much issue with the assertions of the second argument, that the Volcker Rule will make it harder to trade some instruments.

For example, Alliance Bernstein, in its comments on the Volcker Rule, wrote that a prohibition on proprietary trading will raise costs for investors, create uncertainty and increase market volatility.

Volcker asks, in effect, "so what?"

Trading was arguably never easier than in the years leading up to the financial crisis, he points out, and the result was a financial crisis.

"At some point, great liquidity, or the perception of it, may itself encourage more speculative trading, even in longer-term instruments," Volcker writes. "Presumably conservative institutional investors are tempted to turn over positions much more rapidly, at the expense of careful analysis of basic values."

As for the third anti-Volcker argument, that U.S. banks won't be able to compete with foreign banks, Volcker also calls this, essentially, hogwash. Banks will be judged on the services they provide, not their ability to gamble with the house money.

"Deposit and payment facilities, the providing of credit, and asset management – these are the substance of commercial bank customer services," he writes. "Does anyone really think that institutions with highly leveraged proprietary trading will lure this business from solidly capitalized, U.S. banks focused on serving customers?"

Volcker has much less to say about the fourth anti-Volcker complaint, that the rule will make life too complicated and expensive for banks. He essentially concedes the point that it will indeed make life more complicated and more expensive for banks, but says we need to balance that cost against the cost of, you know, blowing up the global economy.

-- Bonnie Kavoussi and Marcus Baram contributed to this story.

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