With the Volcker Rule Now Dead, Democrats Need to Bring Back Glass-Steagall

Richard Drew/Associated Press

It’s clear that overabundant trading with cheap funds backed by public guarantees now represents the major break in the firewall of our financial regulatory apparatus. 

In 2017, when Obamacare looked to be a vote or two away from oblivion, a popular argument in left circles went like this: The Rube Goldberg contraption that is the Affordable Care Act represented a compromise from the easier and cleaner way to do universal health care, and if Republicans and the medical industry couldn’t even stomach that, the next time Democrats take power they might as well go to full single-payer. If Democrats are going to be called socialists either way, the left theorized, they should choose the best policy instead of a half measure in the faint hope of winning bipartisan support.

Democrats now have another example of this in financial reform. Trump’s regulators have finally eviscerated the compromise version of a structural separation between deposit-taking banks and trading institutions, known as the Volcker Rule. The financial sector could not allow even minor constraints on its practices of betting prodigious sums with other people’s money. Well, fine. Then I guess when Democrats retain control they should just go back to the gold standard in this department, the firewall between commercial and investment banks passed in 1933 as the Glass-Steagall Act.

The Volcker Rule was a poor man’s version of Glass-Steagall. Part of the 2010 Dodd-Frank financial reform, it was intended to stop deposit-taking banks from what is commonly called proprietary trading, which amounts to speculative buying and selling of securities or derivatives on its own accounts. The idea here is that bank deposits are some of the cheapest funding there is. Most checking accounts pay either next to nothing or nothing at all in interest. We want banks taking deposits to make loans, but using that cheap funding to gamble adds no productive value to the economy, while increasing risks. And the government backs up that risk with deposit insurance and the prospect of bailouts. So banks get to privatize profits while socializing losses.

Senators Jeff Merkley (D-OR) and Carl Levin (D-MI) wrote the Volcker Rule, and it made its way into Dodd-Frank after a series of struggles. But it was battered along the way. Initially, the rule prevented commercial banks from owning or investing in hedge funds or private equity funds, but then-Senator Scott Brown (R-MA) forced in a loophole that allowed 3 percent of bank capital to be put toward such investments. A number of other types of trading instruments, like Treasury bonds, municipal bonds, and securities issued by government-sponsored mortgage giants Fannie Mae and Freddie Mac, were also exempted. Finally, there were exceptions for so-called “market-making” or hedging strategies. If a bank traded certain financial products and claimed that they offset potential losses on other parts of their business, it would be allowed under the rule.

After the legislation passed, regulators kept making concessions to Wall Street, delaying key pieces of the rule repeatedly and buying time for lobbyists to continue to chip away at it. That paid off last week, when the Federal Deposit Insurance Corporation approved a revamped version of the Volcker Rule. The Office of the Comptroller of the Currency also signaled support; other regulators with jurisdiction over the rule are expected to follow suit in the coming weeks.

The new version expands the market-making and hedging exemptions to cover a large number of possible bank trades. It eases the “covered funds” provision, allowing banks to invest more in hedge funds and private equity. If a bank holds a financial instrument for more than 60 days, it’s presumed not to be proprietary trading under the rule, forcing regulators to rebut that.

Perhaps most important, an “accounting test” that would help regulators identify speculative trades was dropped, in favor of what amounts to self-policing. There is a “presumption of compliance” for certain activities, and an exemption for all trades within “risk limits” that the banks themselves have created.

All you need to know about what’s left of the Volcker Rule can be summed up by Tyler Gellasch of the organization Healthy Markets, who wrote on Twitter: “After tens of millions of dollars and a decade of lobbying, the #VolckerRule is a shadow of the original idea and simply no longer works for anyone—it certainly cannot protect the public from another disaster.” Gellasch is no ordinary financial-reform advocate: He co-wrote the Volcker Rule, while serving as a top staffer to then-Senator Levin. If Gellasch says it’s over, it’s over.

So where does that leave us? With the rewritten rule, there is effectively no structural separation, direct or indirect, between commercial and investment banks. Regulatory authorities the world over, from the Liikanen report in the EU to the Vickers report in the U.K., have recognized the need to “ring-fence” risky assets and prevent governments from subsidizing investment banks with public money. We shouldn’t want ordinary Americans’ savings entangled with, and indeed funding, high-stakes casino gambling. Banks shouldn’t be staking hedge funds and private equity firms to make their reigns of terror more robust and predatory, either.

So how can we stop this now? A half measure, the Volcker Rule, was nicked to death and finally sent off to its resting place. The alternative is to move forward with the thing that the Volcker Rule stood in for: Glass-Steagall. It’s clear that overabundant trading with cheap funds backed by public guarantees now represents the major break in the firewall of our financial regulatory apparatus. That leak can be plugged simply, by separating commercial from investment banks. We tried it the Rube Goldberg way, and Republicans at the behest of the industry revolted. The next step is a direct restoration of the real thing.

Financial regulation has played no role whatsoever in the Democratic presidential primary. Elizabeth Warren has a long-standing bill restoring Glass-Steagall, and Bernie Sanders ran on the idea in 2016. Everybody else has been silent. You can certainly go further than Glass-Steagall, by banning unproductive trading activities, reducing conflicts of interest, and eliminating financial intermediaries with no value for the economy.

But we should at least hear something from would-be Democratic standard-bearers. We’re at the scariest point on the pendulum between financial implosion, re-regulation of the system, and then relaxation of those rules. The Trump administration is laying the groundwork for the next financial crisis, and we need to know what candidates would do to reverse that trend before we have another crash.

The simplest way to attack the most dangerous facet of the financial system, its extreme interconnectedness that enables problems in one section to cascade everywhere, is to just separate out the activities. The Volcker Rule was the end-around version of this, and Wall Street killed it. The time for half steps that financial lobbyists treat like Armageddon anyway has ended.

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