Everything that needs to be said has already been said.
But since no one was listening, everything must be said again.

Andre Gide

Tuesday, May 4, 2010

The Volcker Rule

A number of my colleagues and myself (at the FRB St Louis) attended a meeting yesterday with Paul Volcker to hear him opine on the so-called Volcker rule. (He spoke later that evening at Washington University; see here). I haven't followed the debate on financial sector reform very closely, so I learned a few things.

The central "problem" is the too-big-to-fail issue. How do we deal with it? Enter the Volcker rule.

If I understand correctly, the Volcker rule consists of two parts: [1] A rule determining which institutions are in and out of the social safety net; and [2] A rule determining how institutions out of the safety net, yet important to the financial system, are to be treated in the event they become distressed.

In a nutshell, rule [1] says you are in if you act like a traditional deposit-taking bank. If you want to engage in proprietory trading, then fine, but you will not be included in the safety net (e.g., access to the discount window). Rule [2] consists of some sort of "resolution authority" with the mandate to take over any troubled financial firm that threatens the system, and liquidate its assets in a timely manner. These firms will be allowed to fail.

I do not think that Volcker pretends that this is the solution to the TBTF problem or that this rule, in itself, will lead to perpetual stability. He seems to think, however, that it is an important first step. Well, naturally we had a few questions.

I decided to bring up a few points raised by Steve Williamson
here on why TBTF does not seem to a problem in Canada. He replied that Canadian banks were more prudent in their lending. I tried Steve's line that this was likely the product of better regulation; there is no Volcker rule, as far as I know, in Canada. His reply, at least a part of it, was that Canadian banks did not engage in a lot of proprietory trading anyway.

Well, what could I say? I let it lie there. There were, after all, many other things to talk about. I thought it interesting that he brought up the issue possible systemic risk among those firms outside the safety net. Could the resolution authority really be expected to shut down a large "non bank" financial player? He seemed well aware of the shortcomings and delicate issues involved with any regulatory proposals. Some of his interesting (radical?) views can be found

He has quite the sense of humour too, I must say. On Goldman Sachs and conflict of interest he said that GS reminded him of an apple (possibly NYC) full of worms. GS is so intertwined in the finanical sector that every trade they make is a conflict of interest.

The best part, however, was when during one of his explanations, a cell phone started ringing softly. He stopped talking and looked around, but soon discovered that the offending piece was his own. So he leans back in his chair and slowly pulls the phone out of his pocket. He opens it, brings it slowly to his ear and with a deadpan delivery barks out: "Let them fail!" ...and then immediately hangs up.

I nominate Volcker to head the resolution authority!


  1. Would Canadian banks be in the same situation if the real estate market dropped the same degree?

  2. Pointbite:

    Not sure what you're asking. Would Canadian banks be hit hard if Canadian real estate tanked as in the US? No question about it.

    Are you suggesting that Canadian banks have to this point been saved by a continuing real estate "bubble" in Canada?

    A competing hypothesis might be that real estate prices have remained firm in Canada because they avoided the price-depressing effect of a wave of foreclosures by making more prudent mortgage loans in the first place.

  3. Hilarious! Thanks for sharing.

    Volker defeated the Soviet Union so I think he is God. (Well, not really, but the notion amuses me.)

  4. I had heard somewhere, possibly incorrectly, that Canadian banks were in severe trouble -- worse than the US, but that somehow it's all being hushed up. I guess that sounds like I'm a Canadian conspiracy theorist.