Economix Blog: Simon Johnson: Last-Ditch Attempt to Derail Volcker Rule

Simon Johnson is the Ronald A. Kurtz Professor of Entrepreneurship at the M.I.T. Sloan School of Management and co-author of “White House Burning: The Founding Fathers, Our National Debt, and Why It Matters to You.”

In a desperate attempt to prevent implementation of the Volcker Rule, representatives of megabanks are resorting to some last-minute scare tactics. Specifically, they assert that the Volcker Rule, which is designed to reduce the risks that such banks can take, violates the international trade obligations of the United States and would offend other member nations of the Group of 20. This is false and should be brushed aside by the relevant authorities.

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The Volcker Rule was adopted as part of the Dodd-Frank financial reform legislation in 2010. The legislative intent was, at the suggestion of Paul A. Volcker (the former chairman of the Federal Reserve Board of Governors), to limit the kinds of risk-taking that very large banks could undertake. In particular, the banks are supposed to be severely limited in terms of the proprietary bets that they can make, to lower the probability they can ruin themselves and inflict great damage on the rest of society. (For a primer and great insights, see this commentary by Alexis Goldstein, a leader of Occupy the S.E.C.)

The Volcker Rule is almost finished winding its way through the regulatory process, and a version should be implemented soon. But in a last-ditch attempt to block it, the United States Chamber of Commerce has sent a letter to the United States Trade Representative asserting:

The Volcker Rule is discriminatory, as foreign sovereign debt is subject to the regulation, while Unted States Treasury debt instruments are exempt. This creates a discord in G20 and invites foreign governments to retaliate at a time when we need those same regulators in foreign countries to support initiatives to liberalize trade in financial services. Further, U.S.T.R. should conduct a very close examination to ensure the Volcker Rule does not violate any of our trade obligations.

This statement is correct with regard to the point that there are exemptions in the current version of the Volcker Rule for banks’ holdings of United States government debt, i.e., there are fewer restrictions on their holdings of Treasury obligations than on their holdings of foreign government debt.

But the idea that this violates the spirit or letter of our international obligations is flatly wrong. Perhaps that is why the letter doesn’t point to any particular provisions of any specific trade agreements.

As a matter of basic principle, there is no violation, because there is no provision in any trade agreement that says United States banking regulators can’t protect our financial system by engaging in prudent regulation. To the contrary, nations have always been allowed to restrict what their banks can regard as safe assets, and thus effectively to limit their holdings of foreign assets.

Think of it this way. Would we want United States banking regulators to be prohibited from distinguishing between United States debt and that of Greece, Ireland, Spain or Italy?

In practice, this distinction among countries already occurs. For example, the Basel II equity capital requirements allow every country to treat the debt of other governments with some caution (although, without doubt, more caution is needed than was actually used in the past, or even than is encouraged under the new Basel III agreement).

Some Canadian officials, for example, have said that Canadian government debt should receive equal treatment with United States government debt. This is a dangerous proposal. Canada has ridden the recent commodity price boom and, to many observers, its real estate looks pricey. Do Canadian banks have enough loss-absorbing capital to weather whatever storms lie ahead – if China slows down or energy prices fall for some other reason? They had trouble in the 1990s, when commodity prices fell sharply. Why should American regulators allow our banks to take on a huge amount of Canadian risk?

Markets love a country until five seconds before they hate it. Surely we should have learned that by now, including from the European crisis.

We should continue to regard euro-zone debt with great suspicion. The euro-zone sovereign debt crisis may be over, and Greece’s bond rating was upgraded sharply by Standard Poor’s this week. On the other hand, S.P. and other ratings agencies have been wrong – and to a spectacular degree – in the not-too-distant past, including being overly optimistic about European sovereign debt and residential mortgages in the United States.

The Volcker Rule, and its international counterparts, like “ring fencing,” are forms of re-regulation, to be sure. Based on harsh recent experiences, countries are backing away from letting their banks and other people’s banks run unfettered around the world, taking on whatever risks they like and getting themselves into complicated legal and financial difficulties.

We need to reduce excessive and irresponsible risk taking throughout our financial system. The Volcker Rule is a significant step in the right direction. It is time for the regulators to finish the job.

Article source: http://economix.blogs.nytimes.com/2012/12/20/last-ditch-attempt-to-derail-volcker-rule/?partner=rss&emc=rss