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Problems of the Volcker Rule and Glass Steagall

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Tuesday, 14 February 2012 05:38

Andrew Ross Sorkin has a lengthy discussion of the complexities of the Volcker rule, which bans proprietary trading by banks that hold government guaranteed deposits. The point of the rule is that banks should not be taking risks with taxpayers' money.

While Sorkin ultimately comes down in favor of the rule, he neglects to point out that until 1999 there was a much stricter rule in the form of the Glass Steagall separation between commercial and investment banking. Up to that point, investment banks like Goldman Sachs and Merill Lynch could do whatever trading they wanted. In principle they were not putting government money at risk, since they did not enjoy protection from the Fed and the FDIC. These banks also made large profits.

If banks now find the Volcker rule to be too onerous, as they claim, then there is no obvious reason they could not just separate their investment banking and commerical banking divisions so that they are again independent companies. It is certainly understandable that the banks would prefer to be able to gamble with taxpayers money (who wouldn't?), but they really don't have much of a case.

btw, Sorkin begins his piece with a paean to Volcker:

"It is hard to disagree with Paul A Volcker.

"But I will.

"On Monday, Mr. Volcker, the former Federal Reserve chairman who almost single-handedly rescued the United States from the stagflation crisis of the late 1970s."

Whether or not one agrees with the interest rate policies that Volcker used to slow inflation, which gave us double digit unemployment, it is a bit hard to describe Volcker as uniquely talented. All wealthy countries saw a sharp decline in their inflation rates at the beginning of the 80s. This suggests that Mr. Volcker's skills were not needed to bring inflation down.

Comments (3)Add Comment
foreign banks object to Volker rule
written by Jane Flemming, February 14, 2012 7:59
Do foreign banks, I'm particularly thinking of Canadian banks, but apparently there are others, have good reason to object to aspects of the Volcker rule? We're being told that "the proposed rule could severely impact the liquidity of Canadian government debt markets and interfere with the risk management practices of Canadian banks." (Jim Flaherty - Finance Minister). I find this peculiar given the main reason given for our banking system avoiding the problems of the US banking system is that we retained that wall between commercial and investment banking, so I'm confused, and undoubtedly ill-informed.
...
written by Rogermac, February 14, 2012 10:54
When starting a new paragraph within an extended quotation, it is customary to begin that new paragraph with quotation marks. This avoids confusing the reader as to who speaking. This would have made it clear that the words "But I will" in Baker's post come from Sorkin, not Baker.

I know, a nit.
...
written by Calgacus, February 15, 2012 2:52
Jane Flemming, it sounds to me like Flaherty is talking nonsense, parroting idiotic words someone miseducated in economics has told him, without any thought or empirical reality intervening at any stage. Looking at Sorkin's article, he clearly doesn't understand what he is talking about. Interest rates, the yield curve, on Canadian government bonds are whatever the Canadian government decides them to be. Removing US banks from brokering them would have very negligible effect on the debt of a major country with a reserve currency, the only effect I see is that the vig, the microscopically increased minimal fraction of trading costs going to financial intermediaries would be more likely to go to Canadian institutions. That's a problem?

the Volcker Rule is going to make the United States banking business less competitive with foreign rivals That's like saying US tapeworms are going to be less competitive than foreign ones. Let's hope so.

Your sensible arguments & confession of confusion & ill-informedness qualifies you in reality to be a much better finance minister than any minister I know of of any major country, China excepted.

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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.

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