The Volcker Rule

The Volcker Rule ( 619[1] (12 U.S.C. 1851) is part of the DoddFrank Wall Street Reform and
Consumer Protection Act (Pub.L. 111203, H.R. 4173), which President Barack Obama signed
into law in July 2010. It is named after its recommender, Paul Volcker, who served as the
chairman of the Federal Reserve from 1979 to 1987 and became the chair of the Presidents
Economic Recovery Advisory Board in 2009. Volcker argued that speculative activity on the part
of banks was a major factor in the economic crisis that unfolded between 2007 and 2010, that the
continuance of such speculative activity posed an unacceptable level of systemic risk, and that
banks increased use of derivatives only heightened this risk. Therefore, the purpose of the
Volcker Rule is to prevent banks from making various types of speculative investments. With
some exceptions, it prohibits these financial institutions from participating in the short-term
proprietary trading of derivatives, securities, options, and commodity futures. (Proprietary
trading refers to a firms use of its own moneyas opposed to its depositors moneyto trade
financial instruments for its profit rather than that of its clients.) The Volcker Rule also restricts
banks ability to own, sponsor, or establish relationships with hedge funds and private equity
funds (covered funds). Although its proponents hoped to see its implementation coincide with
that of the rest of the Dodd-Frank Act, the passing of the Volcker Rule faced delay. Financial
leaders voiced their concerns that the governments actions would reduce their firms ability to
compete, and thus their overall profitability. Some political leaders also raised doubts that the
banks speculative activities were the root cause of the financial meltdown, as well as concerns
that the Volcker Rule would further damage the economy by interfering with the dealings of
private institutions. The Federal Reserve Systems Board of Governors, the Office of the
Comptroller of the Currency, the Commodity Futures Trading Commission, the Federal Deposit

Insurance Corporation, and the Securities and Exchange Commission approved the regulations
associated with the Volcker Rule in December 2013. The Volcker Rule went into effect on April
1, 2014. The law required banks to be in full compliance by July 21, 2015.
The Volcker Rule is part of a greater effort to eliminate the mentality that some financial
institutions are too big to fail. In 2010, Senators Jeff Merkley (D-OR) and Carl Levin (D-MI)
introduced the chief component of the Volcker Rulethe call for restrictions on proprietary
tradingas an amendment to the larger Dodd-Frank legislation. Their amendment never
received a vote. First, Senator Richard Shelby (R-AL) objected to a motion to vote on it.
Merkley and Levin then attached the amendment to a piece of legislation that Senator Sam
Brownback (R-KS) had proposed, but this effort failed when Brownback withdrew his
amendment. The House-Senate conference committee eventually passed a version of the Volcker
Rule that included the language of the Merkley-Levin proposal. This version called for stronger
regulations on proprietary trading than the Obama administration had suggested, and it also
prohibited conflict of interest trading. However, the new proposal could not pass without the vote
of Senator Scott Brown (R-MA), who requested changes to the proprietary trading ban. The
Volcker Rule thus received further amendment, this time to allow banks to invest three percent of
their Tier 1 capital into private equity and hedge funds. This adjustment also permitted banks to
engage in the proprietary trading of treasuries, municipal bonds, and bonds issued by Fannie
Mae, Freddie Mac, and other government-backed entities. In addition, the modified version
allowed for market making trading based on banks calculations of their Reasonably Expected
Near Term Demand of Customers (RENTD).
A number of firms, including JPMorgan Chase &Co., Goldman Sachs, and Bank of America,
have submitted public comments expressing their objections to the Volcker Rule. The leaders of

these financial institutions are concerned that the restrictions will reduce their competitiveness in
the marketplace and severely cut their profits. Some Republican lawmakers, such as
Representative Spencer Bachus of Alabama, have voiced similar concerns and vowed to limit the
effectiveness of the Volcker Rule. One suggestion has been to cut funding to the regulatory
agencies that enforce the banks compliance. Although Paul Volcker has stated that he would
have preferred a less complicated set of regulations, he has also expressed confidence that the
rules backers will prevail.
Despite regulatory agencies formal approval of the Volcker Rule at the end of 2013, challenges
to its full implementation have continued. Financial industry lobbyists have repeatedly pushed
for extensions on compliance deadlines and additional exemptions, and in several instances, they
have succeeded. In December 2014, for example, the Federal Reserve announced that it had
agreed to extend the conformance period for covered funds and foreign funds that had been in
place before December 31, 2013 (legacy funds). The Fed originally planned for this extension
to last until July 21, 2016, but it has since pushed the date to July 21, 2017. In January 2014,
after a lawsuit forced the Federal Reserve Board and regulatory agencies to reconsider whether
banks should be obligated to sell or divest collateralized debt obligations (CDOs) backed by
trust-preferred securities (TruPS), regulators decided that they would allow certain financial
institutions to retain those investments. At the time of this writing, Wall Street lobbyists are still
requesting deadline extensions for hedge and private equity funds.
A number of influential proprietary traders have left major financial institutions for existing
hedge funds, and in some cases formed their own hedge funds, in reaction to the Volcker Rule.
These include Peter Morgan from Morgan Stanley; Todd Edgar and Roger Jones from Barclays;
Matthew McClean, Darren Wong, and Morgan Sze from Goldman Sachs; and Boaz Weinstein,

Pablo Calderini, and Nelson Saiers from Deutsche Bank. Opponents of the Volcker Rule have
referred to this phenomenon as a brain drain and worry that the exodus of top talent from these
large banks will lead to further economic woes. However, supporters of the rule contend that the
departure of these players will help bring about a crucial cultural shift in the banking industry
and thereby prevent another meltdown.
The fate of the Volcker Rule under the incoming Trump administration is uncertain. PresidentElect Donald Trump, who will enter office with Republican majorities in the House and Senate,
has taken the position that a decrease in government regulations will strengthen the economy. He
has been critical of the Dodd-Frank Act in general, arguing that it has prevented the economy
from making a strong, full recovery after the recession. However, he has also demonstrated that
he is not as opposed to government involvement in the economy as many other Republicans are.
Trump has publicly criticized the leadership of some large banks. In 2008, and in the early days
of Barack Obamas presidency in 2009, Trump stated that he agreed with the governments
bailout of the banks. At that time, Trump indicated that he had no objections to the
governments intervening to save the banks, and that even a nationalization of the banks would
have been acceptable. Therefore, the possibility remains that Trump will be receptive to changing
the Volcker Rule rather than calling for its complete abolishment. As a Republican who has
vowed to protect Social Security and recommended tariffs for American companies that have
moved their production plants out of the country, Trump might very well be willing to reach a
compromise on the Volcker Rule and other financial regulations. If that is the case, he will not
only face opposition from free market Republicans. Perhaps more importantly, he will also
face opposition from establishment leaders in both the Republican and Democratic parties who
have strong ties to Wall Street.