Weekend Economists and the Accidental President December 13-15, 2013

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63. How a Simple Idea to Rein In Banks Got Supersized

http://www.bloomberg.com/quicktake/the-volcker-rule/

Merriam-Webster’s Dictionary defines “speculation” in 31 words. The key ones are “risk of a large loss.” When Paul Volcker, the former U.S. Federal Reserve chairman, proposed banning speculation by federally insured banks to reduce risk to the world economy, he did it in one paragraph. Four years later, the nation’s regulators issued a final rule based on Volcker’s proposal. It runs close to 100 pages, with hundreds more in supporting material — and no one is quite sure how it will be enforced. It’s a lesson in how complicated simplifying Wall Street can be.

The Situation

Dodd-Frank reforms of 2010. Even as draft rules were being fought over, many banks shut down the desks they used for trades that were solely for their own account, what’s known as proprietary trading. Banks do other kinds of trading that can also make them money, or lose it. One involves the steady stream of securities banks buy, sell and hold so their customers can always buy what they want to buy and sell what they want to sell, an activity called market-making. Another involves trades to offset the risks of a bank’s own transactions, known as hedging. The rule approved Dec. 10 is more lenient on market-making and tougher on hedging than was originally proposed: Regulators grew wary after JPMorgan Chase’s $6.2 billion London Whale loss, which many saw as closer to gambling than to a hedge. Now Wall Street is waiting to see how regulators decide to enforce the rules. The responsibility is split between five agencies with very different agendas. Some care most about keeping markets working smoothly, while others worry most about keeping banks from blowing themselves up.