Volcker Rule Misses the Mark

Today Paul Volcker appears before the Senate Banking Committee to argue for the separation of proprietary trading and commercial banking.  In Mr. Volcker’s own works “what we plainly need are authority and methods to minimize the occurrence of those failures that threaten the basic fabric of financial markets.”

Using his own test, the Volcker Rule fails miserably.  Had this rule been in place say five or even ten years ago, we’d most likely be in the same place we are today.  It would have not avoided the crisis, and may potentially have made it worse.

First of all the proposal ignores the fact that those institutions at the heart of the crisis, Bear, Lehman, Fannie, Freddie, AIG, were not commercial banks.  They were not using federally insured deposits to gamble in our financial markets.  Those commercial banks with proprietary trading activities that did fail, such as Wachovia, were sunk not by proprietary trading, but by bad mortgage lending.

Mr. Volcker is correct in arguing for a change in assumptions that institutions and their creditors will not be bailed out.  He errs in believing that the House passed financial “reform” bill achieves that.  One has to wonder if he’s bother to even read the bill.  The House bill explicitly allows for rescuing creditors.  The House bill does not reduce the chance of bailouts, it increases them.

While the Obama Administration may have changed the face of its reforms, sadly the substance of its proposals continue to bear little relation to the actual causes of our financial crisis.  Nowhere in the President’s proposals do we see any efforts at avoiding future housing bubbles.  Perhaps this should come as no surprise given Washington’s continued attempts to re-inflate the last housing bubble.