Yesterday's hearing on the Volcker rule did not go very well. In the preceding 24 hours, there was some confusion over whether Dodd supported the rule. Eventually, his spokesperson Kirstin Brose told me he did. Then, at the hearing, the two witnesses, former Fed Chair Paul Volcker and Deputy Treasury Secretary Neal Wolin were clearly not prepared to defend the rule; ironically, Wolin did a much better job making the case than Volcker himself. The problem remains that the administration has yet to specifically define how the two parts of the rule -- one that would separate proprietary trading, hedge and private equity funds from federally insured banks, and one that would limit the size of a bank's liabilities -- would work in practice. This led Dodd to complain, at the end of the hearing, that the administration's late change in its regulatory proposals is "adding to the problems of trying to get a bill done.” Yipes.
Republican criticisms were, typically, all over the board, with Sen. Mike Johanns pretending that the Volcker rule represented the entirety of the administration's proposal, and Bob Corker ignoring the role that Bear Stearns hedge funds played in the crisis and the fact that losses at trading desks played a role in the need to re-capitalize any number of major commercial banks, from CitiGroup to Bank of America.
Basically, a common fallacy these senators (and others) often fall into is that there is one solution to the regulatory mess: Either we don't need to regulate bank size and do need resolution authorities, as Kevin Warsh argues, or the only solution to Too Big To Fail is to make banks smaller through regulation, as Felix Salmon has said.
I think the whole thing is analogous to fire fighting: You definitely want a fire department that does a good job putting out fires (our dissolution authorities, in this example). But you also don't want to skimp on fire alarms, rules about where you can store oil rags, or codes that require your electrical system to be safe (the Volcker rule and other regulatory reforms). Mitigation is important and saves money in the long run, but you still need a rapid response in the event of an unforeseen accident. It's a point I made in this oft-vilified article.
-- Tim Fernholz
