Blog Post

The Volcker Rule

What’s at stake: Obama’s sweeping proposal for financial regulation took the world by surprise. The new White House initiative on limiting bank size and restricting the activities of depository institutions, , including speculative proprietary trading and investing in private equity and hedge funds, drew some words of support but no commitment to follow suit from […]

By: Date: January 25, 2010 Topic: Banking and capital markets

What’s at stake: Obama’s sweeping proposal for financial regulation took the world by surprise. The new White House initiative on limiting bank size and restricting the activities of depository institutions, , including speculative proprietary trading and investing in private equity and hedge funds, drew some words of support but no commitment to follow suit from Britain, France or Germany.  Though not a full return to Glass-Steagall, the law that separated commercial banking and investment banking in the wake of the Great Depression (and was repealed in 1999), it is at least a return to its spirit and marks a significant change in the administration thinking which had until now seemed content to shackle the banks with tougher regulation, including higher capital ratios, rather than breaking them up or limiting what they could do.

The Economist has a concise analysis of what is in the plan. The first half of the plan concerns restrictions on the scope of activities. Banks that have insured deposits, and thus access to emergency funds from the central bank, would not be allowed to own or invest in private equity or hedge funds. Nor would they be able to engage in “proprietary” trading – punting their own capital – though they could continue to offer investment banking for clients, such as underwriting securities, making markets and advising on mergers.  The second part focuses on size. Banks already face a 10% cap on national market share of deposits. This would be updated to include other liabilities, namely wholesale funding. The aim is to limit concentration, which has increased greatly over the past 20 years, accelerating during the crisis as healthy banks bought sick ones. The four largest banks now hold more than half of the industry’s assets.

Simon Johnson writes that at the broadest level, Thursday’s announcement from the White House was encouraging – for the first time, the president endorsed potential new constraints on the scale and scope of our largest banks, and said he was ready for “a fight”.  Increasingly, however, there are very real indications that the conversion is either superficial (on the economic side of the White House) or entirely a marketing ploy (on the political side). Secretary Geithner’s spin on the Volcker Rule, Thursday night, is in direct contradiction to what the president said.  At first, it seemed that Geithner was just off-message.  Now it is more likely that he is (still) the message. Second, the administration’s proposal to freeze biggest bank size “as is” makes no sense at all. Twenty years of reckless expansion, a massive crisis, and the most generous bailout in human history are not a recipe for “right” sized banks.

Viral Acharya and Matthew Richardson, both from NYU’s Stern School of Business, write that it is scope rather than scale that matters most. There is little rationale for hard restrictions on size as it is clear that for diversification purposes as well as efficient market-making or liquidity provision, firms need to be large. It is the complexity of large financial institutions that seems a primary issue in resolving them efficiently, which can be effectively addressed through scope restrictions. On the other hand, separating commercial banking and other forms of financial intermediation from proprietary trading, equity investments and holding of structured investment products is a step in the right direction as it limits systemic risk without affecting financial sector’s ability to perform its core functions.

Paul Krugman does not think that too-big-to-fail is at the heart of our financial problems. Nor does he think a sharp separation between narrow banking depository institutions and other financial players is a silver bullet: unless the shadow banking system is really reined in, financial institutions will create things that look like deposits, act like deposits, but don’t have an FDIC guarantee; yet in crisis, there will be strong incentives to bail them out anyway. Paul Tucker, the Bank of England’s deputy governor for financial stability, made a similar point in a speech noting that banking-style risks emerged all over the financial system in recent years, with little or no relationship to whether the entity was a deposit taking institution or not.

Justin Fox says that the biggest troubles at the big banks and investment banks had to do activities that were related to serving customers. Hedge funds, private equity funds and proprietary trading operations at large banks and investment banks had little to do with the financial crisis we just went through. Yes, there were those two Bear Stearns subprime-mortgage hedge funds that imploded in the spring of 2007. But they would have had about the same impact if they weren’t linked to Bear. The biggest troubles at the big banks and investment banks had to do activities that were related to serving customers. All those toxic CDOs that weighed down Citi and Merrill and UBS were intended to be sold. It’s just that customers stopped buying at some point in 2007.

*Bruegel Economic Blogs Review is an information service that surveys external blogs. It does not survey Bruegel’s own publications, nor does it include comments by Bruegel authors.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

Read article More by this author
 

Blog Post

It’s hard to live in the city: Berlin’s rent freeze and the economics of rent control

A proposal in Berlin to ban increases in rent for the next five years sparked intense debate in Germany. Similar policies to the Mietendeckel are currently being discussed in London and NYC. All three proposals reflect and raise similar concerns – the increase in per-capita incomes is not keeping pace with increases in rents, but will a cap do more harm than good? We review recent views on the matter.

By: Inês Goncalves Raposo Topic: Macroeconomic policy Date: July 8, 2019
Read article More on this topic
 

Blog Post

The breakdown of the covered interest rate parity condition

A textbook condition of international finance breaks down. Economic research identifies the interplay between divergent monetary policies and new financial regulation as the source of the puzzle, and generates concerns about unintended consequences for financing conditions and financial stability.

By: Konstantinos Efstathiou and Bruegel Topic: Banking and capital markets Date: July 1, 2019
Read article More on this topic
 

Blog Post

The June Eurogroup meeting: Reflections on BICC

The Eurogroup met on June 13th to discuss the deepening of the economic and monetary union (EMU) and prepare the discussions for the Euro Summit. From the meeting came two main deliverables: an agreement over a budgetary instrument for competitiveness and convergence and the reform of the European Stability Mechanism (ESM) treaty texts. We review economists’ first impressions.

By: Bruegel and Inês Goncalves Raposo Topic: Macroeconomic policy Date: June 24, 2019
Read article More on this topic
 

Blog Post

The campaign against ‘nonsense’ output gaps

A campaign against “nonsense” consensus output gaps has been launched on social media. It has triggered responses focusing on the implications of output gaps for fiscal policy under EU rules, especially for Italy. But the debate about the reliability of output-gap estimates is more wide-ranging.

By: Konstantinos Efstathiou and Bruegel Topic: Macroeconomic policy Date: June 17, 2019
Read article More on this topic
 

Blog Post

The inverted yield curve

Longer-term yields falling below shorter-term yields have historically preceded recessions. Last week, the US 10-year yield was 21 basis points below the 3-month yield, a feat last seen during the summer of 2007. Is the current yield curve a trustworthy barometer for future growth?

By: Inês Goncalves Raposo and Bruegel Topic: Global economy and trade Date: June 11, 2019
Read article More on this topic
 

Blog Post

The 'seven' ceiling: China's yuan in trade talks

Investors and the public have been looking at the renminbi with caution after the Trump administration threatened to increase duties on countries that intervene in the markets to devalue/undervalue their currency relative to the dollar. The fear is that China could weaponise its currency following the further increase in tariffs imposed by the United States in early May. What is the likelihood of this happening and what would be the consequences for the existing tensions with the United States, as well as for the global economy?

By: Inês Goncalves Raposo and Bruegel Topic: Global economy and trade Date: June 3, 2019
Read article More on this topic
 

Blog Post

The next ECB president

On May 28th, EU heads of state and government will start the nomination process for the next ECB president. Leaving names of possible candidates aside, this review tries to isolate the arguments about what qualifications the new president should have and what challenges he or she is likely to face.

By: Bruegel and Konstantinos Efstathiou Topic: Macroeconomic policy Date: May 27, 2019
Read article More on this topic More by this author
 

Blog Post

The latest European growth-rate estimates

The quarterly growth rate of the euro area in Q1 2019 was 0.4% (1.5% annualized), considerably higher than the low growth rates of the previous two quarters. This blog reviews the reaction to the release of these numbers and the discussion they have triggered about the euro area’s economic challenges.

By: Konstantinos Efstathiou Topic: Macroeconomic policy Date: May 20, 2019
Read article More by this author
 

Blog Post

Is an electric car a cleaner car?

An article published by the Ifo Institute in Germany compares the carbon footprint of a battery-electric car to that of a diesel car, and argues a higher share of electric cars will not contribute to reducing German carbon dioxide emissions. Respondents rejected the authors’ calculations as unrealistic and biased, and pointed to a series of studies that conclude the opposite. We summarise the article and responses to it.

By: Michael Baltensperger Topic: Digital economy and innovation, Green economy Date: May 13, 2019
Read article More on this topic More by this author
 

Blog Post

All eyes on the Fed

Last week the US Federal Reserve left the federal funds rate unchanged and lowered the interest rate on excess reserves. We review economists’ recent views on the monetary policy conduct and priorities of the United States’ central bank system.

By: Inês Goncalves Raposo Topic: Global economy and trade Date: May 6, 2019
Read article More on this topic More by this author
 

Blog Post

Is this blog post legal (under new EU copyright law)?

How new EU rules on using snippets from news publishers and on copyright infringement liability might affect circulation of information, revenue distribution, market power and EU business competitiveness.

By: Catarina Midões Topic: Macroeconomic policy Date: April 8, 2019
Read article More on this topic
 

Blog Post

Secular stagnation and the future of economic stabilisation

Larry Summers’ and Łukasz Rachel’s most recent study documents a secular fall in neutral real rates in advanced economies. According to the authors, this fall would be even more marked in the absence of offsetting fiscal policies. Policymaking in a world of permanently low interest rates may be hard to navigate, especially in troubled waters. We review economists’ views on the matter

By: Inês Goncalves Raposo and Bruegel Topic: Macroeconomic policy Date: April 1, 2019
Load more posts