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The Volcker Rule and Occupy Wall Street

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To understand why there is so much anger directed at Wall Street and Washington, you need only look at the evolution of the Volcker rule. Named for past Fed Chair Paul Volcker, the rule was a compromise he developed last year to deal with a major problem exposed by the financial meltdown. Banks with deposits guaranteed by the federal government were using those deposits to participate in high-risk investments for their own account -- so-called proprietary trading. The Volcker Rule started out with some tough restrictions on that and other high-risk activities.

At the time, many of us pointed out that the solution to the problem was in plain sight and had already proved its effectiveness. The Glass Steagall Act was passed in 1933 after the Pecora Commission investigated the reasons for the 1929 stock market crash and the subsequent failure of many banks. The Commission found that the country had from its inception endured periodic bank runs or bank panics because, in times of financial troubles, depositors preferred putting their money in their mattresses rather than keeping it in risky banks. To correct that, the Act set up the Federal Deposit Insurance Commission, guaranteeing the safety of deposits up to a certain amount. Just as important, it divided financial institutions into two groups -- commercial banks, which had FDIC insured deposits; and investment banks, which could engage in more risky investments but had no FDIC insurance. Commercial banks were to be low-risk, low-return institutions and investment banks were to be high-risk high-return institutions.

That's how it turned out for the next 50 years. The country prospered with no major financial crises. Then, in the late 1980s and into the 1990s the Federal Reserve under Alan Greenspan -- over the objection of previous chairman Volcker -- began easing Glass Steagall restrictions. In 1999, with the support of key Clinton administration officials, Congress passed the Gramm-Leach-Bliley Act. Glass Steagall was entirely rescinded and commercial banks were again allowed to engage in investment banking. It took only ten years for the perhaps inevitable result -- the financial meltdown of 2008.

Now, back to the evolution of Volcker rule. It became clear early in the 2010 debate on the Dodd-Frank Wall Street Reform Bill that there was insufficient support in Congress and the Obama administration for the Cantwell-McCain amendment which I supported to reinstate Glass Steagall. President Obama announced his administration's support of the Volcker Rule. From the beginning there was great skepticism that a rule could ever be enforced that would truly keep banks from engaging in risky proprietary trading. This was especially true when the Senate would not allow a vote on a tough version of the Volcker Rule sponsored by Senators Carl Levin and Jeff Merkley.

So, like most of the other important issues involved in trying to reform Wall Street, the can was kicked down the road by Congress and thrown to the regulators. Over a year after Dodd Frank's passage, the regulators have unveiled a 298-page draft proposal. It includes 350 questions on which the regulators have requested public input. The complexity of the draft alone raises real questions about how it could be enforced. In addition, knowledgeable experts have numerous concerns about the draft's many vague definitions and clear exemptions. There is, for example, an exemption for "market making activities." I promise you high-priced Wall Street lawyers and accountants will have a field day turning this into an instant loophole.

Obviously, Paul Volcker's attempt to confront the real problem of banks making high-risk bets with government-insured deposits has, in just one year's time, evolved into a watered-down excuse for taking little or no action at all.

The Occupy Wall Street demonstrators are being characterized as to the left on the political spectrum. But there is nothing left-wing about wanting what was for many years seen as a very conservative approach to bank size and risk. I have no doubt that Glass Steagall or something very much like it will eventually once again become the law of the land. The only question is how much agony all Americans have to endure before it happens.