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The Trouble with the Volcker Rule

rcwhalen's picture


"I believe that the officers, and, especially, the directors, of corporations should be held personally responsible when any corporation breaks the law."

– Theodore Roosevelt, speech at Osawatomie, Kansas
"The New Nationalism"  August 31, 1910

For a while now I have been saying that the Volcker Rule is a bad idea.  I share the respect and admiration we all have for its namesake, former Fed Chairman and full-time public citizen Paul Volcker.  But Volcker has never been a hawk on bank superivision, especially when it comes to large banks like his former employer Chase Manhattan Bank.  I called Volcker “the father of too big to fail” in my 2010 book, Inflated: How Money & Debt Built the American Dream.  The epyhonimous rule that now terrorizes much of the financial industry is thus especially incongruous and for the following reasons. 


The Volcker Rule seeks to forbid banks from acting as principal in the financial markets for tactical trading gains of any time duration, limiting the investments by the bank to held-to-maturity positions for the corporate treasury.  Most of the comments by the industry, media and other observers have focused on the sales/trading area of the large universal banks affected by the Volcker Rule, but the changes imposed by this draconian prescription also impact the activities of the investment side of the house.  Hold that thought.

In conceptual terms the Volcker Rule is a step back towards the 1930s era Glass-Steagall separation of investment and commercial banking, but only a half-step and this is the crucial point.  The Volcker Rule imposes activity limits on the entire bank without separating the agency and principal functions into different corporate buckets with separate capital in a legal and financial sense.  The Volcker Rule focus on imposing the limitation upon the whole organization does great mischief, as noted by the hundreds of public commenters on the rule. A good summary of the Volcker Rule from Skaden Arps is below:


Keep in mind that most of the capital in a bank is meant to support principal risk taking by the bank, not customers, in the form of either lending or investing, while the agency activities for customers such as brokerage, trust and asset management are relatively less capital intensive, like an order of magnitude less.  By not bifurcating the capital inside the large universal banks between the majority of which is supposed to support principal risk taken in the credit markets and that lesser portion needed to support customer facing activities, the Volcker Rule by definition must reduce liquidity to the financial markets.  All together now: “Duh.”

Last week I spent a couple of hours listening to the head of credit risk at one of the largest banks in the world describe how his lawyers are caught in the crossfire between federal bank regulators and the SEC over what constitutes principal trading for purposes of the Volcker Rule.   Of note, a related issue being brandished with great effect by the bank's tormentors at SEC is whether a bank is trading its own account based upon material non-public information (MNPI) under any circumstances.

Under the Volcker Rule, the bank cannot make markets in any of the securities it has traditionally traded.  If the bank does make a trade for its own account, it must not only justify the action under the Volcker Rule limitations, but must also prove that neither the bank nor its counterparty were in possession of MNPI.  Even if a party inside the bank unrelated to the trade had such MNPI, the bank's lawyers or regulators might object.  Thus the investment side of the bank has been presumed to be guilty and as a result is  shut down completely.  

And under the equally idiotic liquidity rules of Basel III, the bank cannot offer credit in the interbank market unless the facility is 100% backed by liquid assets.  Since the Fed has interest rates at zero, the Basel III liquidity rules essentially want banks to take a negative carry position to fund interbank lending at zero effective yield -- thus there is no interbank lending. JPM CEO Jaime Dimon confirms same in the bank's latest earnings call when he says there is no interbank lending w/o collateralization.  In both cases, a reduction in overall liquidity to the market must be the result of Basel III and the Volcker Rule.

Now consider the trading and investment side of JPM, which accounts for about a third of the bank's $2 trillion in total assets vs. about the same measure of loans.  The other third of JPM’s assets is miscellaneous stuff we’ll discuss later.  Pre-Volcker rule, JPM had dozens of traders working for the chief investment officer of the bank, trading government and agency debt, as well as corporate equity and debt securities for the bank's investment needs.  Most of them had allocations well into triple digits and a mandate to generate income in long-term positions in corporate and even bank paper.

While JPM was not a market maker per se, JPM and the other large universal banks provided extensive liquidity to these markets pre-Volcker Rule, much more than say a mutual fund of similar size would afford.  JPM actively traded these markets because it wanted to keep abreast of the markets, a prudent risk management policy given the size of the portfolio.  But in the age of the Volcker Rule and Basel III, JPMorgan has laid off several dozen traders. 

Like all of the other universal banks, the investment side of JPM will now only operate in the corporate and bank securities markets to purchase for held-to-maturity positions.  All day-to-day tactical trading around the CIO's treasury book at JPM has ceased.   

Again, the obvious and inevitable result is less liquidity in the markets and particularly the market for securities issued by US banks, where JPM and other larger institutions are large investors.  One of the ironies of the Volcker Rule is that it is actually hurting market liquidity for smaller banks which cannot easily access the capital markets. Some of the market participants I have spoken to directly say that 1/3 of the liquidity in US bank securities has disappeared due to the Volcker Rule.  Hopefully the proponents of amending Reg A to increase the size of this exemption to the 1933 Act from $5 million to $50 million or more will go through and partially offset the damage from the Volcker Rule to the markets for small bank securities.

But the real irony of the Volcker Rule in the wake of the financial crisis is that Congress adopted the proposal in the first place.  The actual, well-documented problems of the financial crisis came from the sales and syndicate desks of the major banks, both for cash securities and derivatives.  Front running customer orders, as the Volcker Rule seeks to limit, is a sublime concern compared with losses from deceptive and fraudulent RMBS, CDOs and endless derivations. 

Focusing on the principal activities of the banks w/o addressing the creation and sale of fraudulent securities based on home mortgages and other assets is a major omission of the Dodd-Frank law.  Indeed, one can see the Volcker Rule as a diversion from the real problem over at the syndicate desk, much the same way that the bluster around centralized clearing of OTC credit derivatives misses the point of questioning the existence of the cash-settlement OTC credit market model in the first instance. 

If we want to restore the Glass-Steagall separation between principal and agency activities, that is a reasonable public policy objective, but we need to accept that risk taking for own account is the chief area of capital allocation in most universal banks.  The Volcker Rule's attempt to prohibit banks from engaging in principal investing activities is a nonsense in economic terms and bad public policy because all of the bank’s capital is now taken out of the risk markets.  The Volcker Rule ignores the most basic and elementary facts about bank risk taking in the financial markets and must hurt overall liquidity among financial intermediaries and investors. 

If we want to segregate customer activities from principal trading, that can be done but only if we go into the process fully aware of how banks take risk and support overall economic activity.  The key failing of the Volcker Rule is that it attacks with operational constraints a problem that should be addressed via enforcement of a legal, professional and financial rules between these two important and necessary sides of the house.  Front-running and other activities are illegal and we should enforce those rules.  But if you understand that lending and investing take up the lion's share of the capital needs of any bank, then the convoluted half-measure which is the Volcker Rule of the Dodd-Frank law becomes truly ridiculous.





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Sun, 06/17/2012 - 03:18 | 2533322 fleemingdick
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Thu, 05/24/2012 - 09:03 | 2458439 zagam2
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Tue, 02/21/2012 - 23:09 | 2183217 Diamond Jim
Diamond Jim's picture

Seems to me that we dump this Volker rule and dodd Frank. If the banksters want to fool around with "Their" money that is their perogative.  Less risks might be taken if you separate customer from their "fooling around money". If they screw up, the depositors are ok (??) the banksters go out of business. Just like it is all supposed to happen in capitalism. If the banks need to off set risk...that is what they must do or go back to being boring...making loans, collecting to maturity etc. When the government comes along a says "no one is too big to fail", you have the government to back you up...stupidity, greed and risk taking ensues. there will always be another bank out there to take up the vacuum.

Mon, 02/20/2012 - 13:26 | 2177884 Pike Bishop
Pike Bishop's picture

Is this article an intellectual exercise, or is it just obviating reality for fun?

or is

Here's how it works:

1) First, you bring an an onslaught of power, money, and influence to kill the idea that you know will work. Because it had done so previously. Mostly you attack the guy with the idea.

2) Then you make sure the guy with the idea is marginalized. No matter how grandly you wished to assume the authority of his name. He could just flip the bird, and walk away telling you to fuck yourselves, because you truly will fuck yourselves. This observation no particular genius, as you did so previously and unequivocally by any historic standard.

You win the most important battle of all, first. The guy with the idea also knows what happens if you leave the table. So, he stays to see what he can salvage. The teacher brought in, who was a primary perpetrator of the disaster, likes this. He knows his most powerful adversary is on the defensive.The Lawn Jockey in-charge also likes this, because appearances are important to him. He doesn't want to win. He just wants to look good.

3) Next, you turn over the process to the people most responsive to power, money, and influence. Although in positions of power, they are weak people.

4) You then take this process and carpet bomb it's intention. This includes public statements by the teacher, who was brought in by the Lawn Jockey in-charge, and his fellow minions.

5) The weak people, as expected, create something weak-kneed. There are some remaining vestiges of the original intention of the idea. But, the only thing which is clear, is the massively funded vagueness and 80% probability that some work-around will be possible.

6) In desperation to well-cosmetic this pig, the weak people reach back and pull forward the name of the guy with the original idea, and stick it on their piece of shit. The guy knows it's a piece of shit, but is stuck with supporting it, because there is no chance of anything better being created.

7) The well-funded bashing continues. Much of  the effort is to keep it dangling like a man  fighting contorted in a noose. Since you couldn't quite break its neck, you hope that it will strangle to death before anybody does anything about it. Plus you don't want anybody to act before the collective amnesia sets in, that the people primarily in need of being roped-in have no credibility. Mainly, because they are the ones for whom you need to put up the stop signs, traffic lights, and paint lines on the road because they caused a $7Trillion nationwide auto accident. And they will still whine like a teen-ager who is denied keys to the family car, after totaling one the prior weekend.

8) The collateral benefits of the early dispatch of the original idea is that lower layer assholes who never showed up in the beginning, now call something, which was clearly intended to be a pig with lipstick and eye-shadow by all involved, the turd that it is. Then they take their self-awarded victory lap.

Their discussion having commenced with rare insights like age has something to do with what will work, and what won't work. And then looked into his crystal ball for scenarios, some real, some imagined, as to why traffic lights, stop signs, and speed limits make everybody take longer to get from one place to another.


Volcker originally wanted a total separation of speculation business from the business of savings deposits and lending. Period.


The principle behind the solution is it's Occam's Razor simplicity. There is no substitute for physical separation of the entities involved. It has been proven that the discretion of Regulators is often flawed, and they are easily captured. Then there is the clear rule of law, to prevent this poor and easily manipulated discretion. But Regulators can effortlessly avoid enforcing the rule of law.

Volcker had no association whatsoever, with the weak people who named this provision after him. He wasn't in Washington at the time, and later made it official with resignation.

He certainly learned a lesson, because he now has to defend something, only because it has a few things in it which might work to some positive outcome. maybe. Which is close to, but very near nothing.

For failed businessmen like Jamie Dimon, and ineffective failed businesses with their predominant belief system which failed completely...

Failed businessmen and failed businesses are a lousy utilization of capital.

And yes, painted lines do impact rewards. When you are reducing risk, it is impossible for it not to effect rewards. In fact, if it doesn't impact rewards, then you know you haven't reduced risk.


Mon, 02/20/2012 - 12:14 | 2177632 Captain Willard
Captain Willard's picture

This article may be the biggest piece of shit yet posted on Zero Hedge.

When this assclown agrees to remove federal deposit insurance from banks which want to trade for their own account, then I will take the author seriously. The author is worried about liquidity in some obscure CDS or swap market when the whole fucking system is grinding to a halt. It's like complaining about a slow bartender on the Titanic.

Mon, 02/20/2012 - 11:31 | 2177478 battlestargalactica
battlestargalactica's picture
“The more powerful the class, the more it claims not to exist.”
? Guy Debord, The Society of the Spectacle
Mon, 02/20/2012 - 09:05 | 2177123 Coldfire
Coldfire's picture

Yes, because it is important to keep the Ponzi alive.

Sun, 02/19/2012 - 19:29 | 2176087 pmm009
pmm009's picture

Time to short hookers and stripers in Manhattan

Sun, 02/19/2012 - 19:12 | 2176033 Fred Hayek
Fred Hayek's picture

I laughed out loud at the part where he said the huge bank is being "tormented" by the SEC. What, are they shorting internet porn sites or something?

Sun, 02/19/2012 - 18:39 | 2175960 pmm009
pmm009's picture

Stop dancing around the issues and say what you think should happen and what the government is trying to do.  Clearly, Washington is trying to take back some control from NY.  If the banks cannot flash trade this crap, they don't need so much capital, they will have to therefore shrink, give back capital via dividends buybacks etc., and hopefully come out the other end with much larger equity ratios, a much larger propensity to underwrite productive ventures, preferably US domestic high value added goods and services, and less likely to destroy the middle class in favor of economic development in develoing nations, nations that are in many cases our enemies.  The government in the US and UK allowed the banks to build, and I would love to know how 50 years of GDP worth of derivatives effects the money supply, so they could compete with the Europeans on a global basis.  That game is over, as a simple 10 billion blocking stake could destroy them.  Notice how nobody even breaths a word as to who may actually hold these stakes to the public.  As the European capital tide recedes from south, central and east asia, our banks don't need as much capital to compete.  The US & China will be the long term winners.  The questions is...who will be in the US middle class in 10 years from today?

Sun, 02/19/2012 - 17:49 | 2175872 DeadFred
DeadFred's picture

So I see that politicians who took campaign funds from the megabanks passed inept rules that disproportionately hurt the smaller competitor banks. I'm floored with surprise. What is more predictable, that they hurt the TBTFs competitors or that they're inept? It's a hard choice.

Sun, 02/19/2012 - 17:07 | 2175786 falak pema
falak pema's picture

TBTB will have to do something, this cancer has to be aggressed. No running away. And its world wide.

Sun, 02/19/2012 - 17:05 | 2175783 Ripped Chunk
Ripped Chunk's picture

Father of "Too Big to Fail". Really? How big were banks then and how big did they become over the next 10 years? No where near what they became in the late nineties and up to the collapse. And "derivatives" (off balance sheet bets for the uninformed) were in their infancy. But became the biggest trading risk of all by far.

The problem with the Volker Rule which is not addressed by you is that the banks will buy their way around complience which has been the norm for 15+ years.

Don't post again until you understand the issues. Please.

Sun, 02/19/2012 - 17:00 | 2175774 Zero Govt
Zero Govt's picture

the problem with banks is leverage.. not the risks taken

leverage is another word for greed

the problem is human, not about rules or piling on restrictions until you have a zombie wearing a straight jacket also having to carry a Rule Book with 1,200 regs to comply with

there is only one solutin to human greed: bankruptcy (ie. the free market)

Fuck the Rules, including Volckers.

They have never worked and will never work

Let banks die, it's the only way

Sun, 02/19/2012 - 17:26 | 2175827 MacroAndCheese
MacroAndCheese's picture

Exactly, and to do that they can't be too big to fail.  Which the Volcker Rule does nothing to address.  It misses the point.

Mon, 02/20/2012 - 18:41 | 2178875 Zero Govt
Zero Govt's picture

the reason these Big Banks are too big to fail is because of the Law (and protection racket of Govt)

if the Govt would fuck off out the way the free market, in the guise of smaller, faster, smarter competitors would have chopped these diseased dinosaurs down to size decades ago

we have the zombie banking industry Govt deserves.. the Govt built, nurtured and protected these cancerous criminal enterprises afterall

we'd already be over the worst since 2008 if the free market was let to work and killed these failed bwankers.. there would already be dozens of fresh new banks on the block taking their place in the sun (the green shoots everyones looking for)

Nobody in history has ever out-thought the infinite wisdom of the free market ...least of all that total loser Barney Frank

Sun, 02/19/2012 - 16:57 | 2175771 JustACitizen
JustACitizen's picture

I thought the point was to make the account holders funds safe. If the bank's shenanigans were limited to the actual capital of the bank - like retained earnings then all would be good. But we all know that the modern art of accountancy makes this into a joke.

Ordinary depository banks should be a freakin' utility and advertised as such. If you want to put your money in an investment bank - you should have that right - but don't bitch when they go under and you lose your funds. The government "guarantee" should be restricted to the utility type banks.

But, it will never happen.

Mon, 02/20/2012 - 11:54 | 2177566 Canucklehead
Canucklehead's picture

There are some interesting things happening in Singapore. 

Martin Armstrong thinks the megatrend is to move the financial industry to Singapore to escape the lack of regulatory enforcement found in New York and London.

Sun, 02/19/2012 - 16:50 | 2175755 max2205
max2205's picture

End front running....rrrrrright!

Sun, 02/19/2012 - 16:50 | 2175733 spinone
spinone's picture

George, liquidity is a code word for consequence free, unlimited risk taking with other people's money.  And yes, finance is connecting savers with productive uses of capital.  But there are no more savers or productive users of capital in the USA. So, financiers all sit in a room and sniff each others farts, and call it securitization. 

Sun, 02/19/2012 - 15:36 | 2175555 GeorgeNY
GeorgeNY's picture

Keep in mind that most of the capital in a bank is meant to support principal risk taking by the bank, not customers, in the form of either lending or investing, while the agency activities for customers such as brokerage, trust and asset management are relatively less capital intensive, like an order of magnitude less. 

This assumtion pretty much guarantees that you will end up at your conclusion. Is it not the point of the Volcker Rule to cut back on this kind of risk taking and refocus the banks on their roles as intermediaries?

Not to get my head shot off but what is so important about liquidity? I thought the point of capital markets was to allocate capital and provide some form of duration intermediation. Not for anything but is the world really going to fall apart if you are unable to trade something within a nano-second of thinking about doing it? Just saying some "market" is going to disappear or have "liquidity" issues proves nothing. Saying a few traders got laid off also means nothing. How does the loss of a particular market or series of markets lead to lower investment in the real economy or a misallocation of capital in the real economy. Again. I mean bricks and mortar economy (for want of a better term) not just that some financial institution will fail. You are providing a service. Financial trading is not an end in itself. 

Sun, 02/19/2012 - 18:31 | 2175930 11b40
11b40's picture

I wanted to give you a greenie, but it won't let me.

In blunt terms, screw the big banks.  Break them up and let them be either regualr bankers for ordinary Americans with Government insurance protections, or traders/investment bankers, but not both.  That is the entire point.  Basic banking is not that complicated and not that risky.  Nor do we need giant conglomerates to provide for societies required banking needs.  Beyond Federally insured and regulated banks, there should be zero government backing for "socializing" one thin dime of bankers losses.

Oh yes, screw Jamie Dimon & the other pricks who WANTED to be allowed to be a bank when it was to their benefit.  Now, they come sniveling about the new rules after causing the freaking mess and getting bailed out while holding a gun to the heads of our stupid and corrupt politicos.

Truly, there are few more important issues of our time, and guess who is zeroing in on it?  Just wait till the weather warms, bitchez!

Occupy the SEC



Occupy the SEC has submitted a 325 page letter to the SEC, FDIC, the Federal Reserve and the OCC, to comment on the notice of proposed rulemaking for the Volcker Rule. In our comment letter, we answered 244 out of 395 questions asked by the Agencies.

The Agencies involved in the Volcker rulemaking process have an historic opportunity to redress many of the economic wrongs of the past, and create a future that privileges the interests of the many rather than the few. We ask that the Agencies vigorously implement the considerable responsibilities that have been discharged to them by Congress, remain faithful to the statute’s intent and consider the comments contained in this letter.
PDF of our Comment Letter

Occupy the SEC's Comment Letter on the Volcker Rule on Scribd

Do NOT follow this link or you will be banned from the site!