Obama’s economic adviser and his battles over the financial-reform bill.by John Cassidy
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In March, Volcker threw his support behind Merkley and Carl Levin, who had formulated a more explicit statement of the Volcker rule than the somewhat vague language in the bill that Dodd was proposing. Anthony Dowd worked closely with the staffs of Merkley and Levin, making sure that their amendment didn’t contain any loopholes. Volcker also joined with the Treasury and the Democratic leadership to head off some more far-reaching proposals. After Senator Blanche Lincoln, a Democrat from Arkansas, put forward an amendment that would force the big banks to move their derivatives-trading desks into separate subsidiaries backed by more capital, Volcker wrote a letter to Dodd saying that such a move was unnecessary, providing that the Merkley-Levin amendment was enacted. And, when the Democratic senators Sherrod Brown, of Ohio, and Ted Kaufman, of Delaware, called for size limits that would have forced many big banks to split up, Volcker made it known that he didn’t favor going that far. “I’m not a barn burner,” he said to me. In May, the Brown-Kaufman amendment was put to a vote and was roundly defeated.
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Volcker and his associates also suspected that some Administration officials were willing to make too many concessions to Wall Street, including on the Volcker rule. “I know the President, and I heard him say in a group that this is an essential part of the bill,” Volcker told me. “I think some other members of the Administration may be somewhat less enthusiastic about it.” While we were talking, an assistant came into Volcker’s office and said that Timothy Geithner was on the line. I went outside into the hallway so that Volcker could take the call. About ten minutes later, he came to the door. “We are in total agreement,” he announced, with a smile that suggested that that might not be the whole truth.
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Volcker has pointed out that professional economists didn’t do a very good job of predicting the most recent crisis. The Volcker rule was intended not as a substitute for broader reform but as a supplement to it, and as a way of grasping the too-big-to-fail problem. If the stricter version contained in the Merkley-Levin amendment had survived, Goldman Sachs and Morgan Stanley, the last two big Wall Street firms, would probably have given up their banking licenses in order to protect their lucrative trading operations. In his mind, Volcker would have succeeded in re-creating a strict dividing line between those institutions which can rely on a government safety net (the biggest commercial banks) and those which can’t (all other big financial firms). The weaker version of the Volcker rule that was passed into law leaves many things, as Volcker says, “in a holding pattern.” Goldman Sachs and Morgan Stanley appear determined to retain their current status and to try to squeeze as much proprietary trading and hedge-fund sponsorship as they can under the new rules. The big commercial banks, such as JPMorgan Chase, could well hold on to their in-house hedge funds and private-equity funds, albeit with smaller ownership stakes.
Volcker may have won the intellectual debate, but, as he readily concedes, the practical challenge lies ahead. Two years from now, when the Volcker rule goes into effect, some firms may well try to skirt it, by, for example, placing big proprietary bets and trying to define them as something else. Without the legislative purity that Volcker was hoping for, enforcing his rule will be difficult, and will rely on many of the same regulators who did such a poor job the last time around, particularly those at the Fed. If the Obama Administration had been able to force the banks to hold a lot more capital in perpetuity, this would not matter very much: a financial system with low leverage can survive the occasional implosion. But international negotiations on a new set of capital requirements are going slowly, and there is no assurance that they will yield meaningful results. If they don’t, once the next credit boom gets going, leverage ratios will start rising again.
more Great article. Who knew Volcker was against Brown-Kaufman?