The Volcker Rule

One of the holdups preventing the financial reform bill from making it through the joint House-Senate committee continues to be the so-called Volcker Rule, which would greatly inhibit the ability of banks to move beyond their traditional lending role. The rule would keep banks from making proprietary trades with their customers’ money, keep them from sponsoring or investing in hedge funds and private equity funds, and cap their market share in order to keep them from becoming “too big to fail.”

People who study the banking industry say that imposition of such a rule could cut banks’ profitability by anywhere from 12 to 35 percent. But Paul Volcker, the former Fed chair under Ronald Reagan who is widely credited with wringing the double-digit inflation of the late 1970s out of the economy, has redoubled his support for the rule. He argued yesterday against providing exemptions for larger banks and allow them to invest in outside funds.

What’s interesting about the Volcker Rule is the momentum it has gained. In the House version of the financial reform bill, passed last December, it wasn’t mentioned at all. (It was formally proposed by Volcker and President Obama in January.) The Senate version included the language, but with a two-year study period for regulators to see if the rule was feasible and sensible. Now, Senate Democrats are reportedly trying to insert an even tougher version of the rule they passed just a few weeks ago.

With the stabilization of the financial sector, we might have expected to see the reverse, with tough new rules for banks being watered down over time as the banking crisis receded in memory. Instead, we have just the opposite.