Will the Volcker Rule change the culture of Wall Street?

December 10, 2013 at 12:00 AM EDT
Paul Volcker
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JUDY WOODRUFF: Five years after the financial crisis crippled the American economy, the behavior of Wall Street and other financial firms has been the subject of intense debate, lobbying and legislation.

At the center of financial reform, one rule has attracted more scrutiny than almost any other, the Volcker rule, named after former Federal Reserve Chairman Paul Volcker.

Today, federal regulators spelled out how it’s supposed to work. And now the question is, what kind of impact will it have on reducing risk?

Jeffrey Brown has the story.

JEFFREY BROWN: The Dodd-Frank Act, signed into law by President Obama in 2010, contained hundreds of provisions designed to avoid future meltdowns, among the most controversial, the Volcker rule, named for the former Fed chairman.

MAN: All in favor, please say aye.

MAN: Aye.

MAN: Aye.

JEFFREY BROWN: Its final approval today by five regulatory agencies signals a major shift in practices banks can undertake and their oversight.

In an effort to prevent excessively risky bets, like last year’s so-called “London Whale” trades, which led to $6 billion in losses for J.P. Morgan Chase, the rule bans so-called proprietary trading, when banks trade with their own money for a profit. Banks are still allowed to buy and sell investments for their own clients, known as market-making.

They will also be allowed to hedge those bets against potential losses. But deciding when a hedge crosses into dangerous territory will test regulators and bank officials.

Fed Chairman Ben Bernanke spoke before voting in favor of the rule today.

BEN BERNANKE, Federal Reserve chairman: I note, though, that the ultimate effectiveness of the rule will depend importantly on supervisors, who will need to find appropriate balance, while providing feedback to the board on how the rule works in practice.

JEFFREY BROWN: Large banks have now until July 2015 to fully comply with the rule.

So, what impact will all this have? For that, we’re joined by Dennis Kelleher, president of Better Markets, a not-for-profit financial services watchdog group, and Wayne Abernathy, executive vice president for the American Bankers Association.

Welcome to both of you.

Dennis Kelleher, let me start with you.

You were an advocate for this rule or a rule like this. Remind us why. Why is it needed?

DENNIS KELLEHER, Better Markets: Well, the financial crash in 2008 was the worst crash since 1929. It almost caused the second Great Depression.

And it did cause the worst economy since the Great Depression. It’s going to ultimately cost this country, according to a study by Better Markets, almost $13 trillion. That’s what’s at stake in financial reform, and that’s what’s at stake at the financial reform rules and the Volcker rule, which is meant to reduce the banks’ high-risk gambling, as opposed to the services they provide to the real economy.

Preventing that high-risk gambling is key to preventing another crash, crises and bailouts.

JEFFREY BROWN: All right.

So, he used — Wayne Abernathy, he used the word gambling, and you smiled. Banks, investment banks, financial institutions generally, have been against this. What do you — what’s the impact going to be, do you think?

WAYNE ABERNATHY, American Bankers Association: The impact is really on bank customers.

And that’s why words like gambling are really irrelevant, because what you’re talking about is the ability of banks to fund not only families, but businesses, to fund the economy, to fund us going forward. And the way we’re looking at the Volcker rule is, what impact will this have for the economy going forward, for the future of the customers that rely upon banks to provide the financial services they need to fund their businesses?

Customers like somebody who has a new business they want to take to the next level, they don’t want to borrow money. They want to float a bond. They want to float a security. They need a bank to help them do that to take them to the next level.

JEFFREY BROWN: You’re not against that business for the banks?

DENNIS KELLEHER: Well, not only are we not against that. That has nothing to do with proprietary trading, in fact.

What has happened is, the gambling culture has infected the too-big-to-fail banks on Wall Street, the biggest of the big. And let’s keep in mind there are about 7,000 banks in the United States. The Volcker rule and the ban on proprietary trading is really going to effectively impact less than a dozen of them, the biggest of the big.

What they were doing were making reckless trading and investment divisions that created big revenue and big bonuses. That has nothing to do with providing loans, market-making, and hedging for the businesses of the country and to grow the economy. And mixing those two is a favorite ploy of Wall Street, but it’s not really implicated here.

The high-risk activity is not related to the economically useful activity.

JEFFREY BROWN: Explain that.

I mean, is there a connection? Because I asked you about it and you went right to the loans to small businesses.

WAYNE ABERNATHY: Sure.

JEFFREY BROWN: So what’s the connection between those kinds of loans and proprietary trading?

WAYNE ABERNATHY: We want to make sure that in the actual regulation, there isn’t that kind of connection, because we want to make sure that banks want to be able to continue to meet the needs of their customers, their business customers especially.

JEFFREY BROWN: But why — but why can’t they, even if they — even if they can’t do proprietary trading?

WAYNE ABERNATHY: Because the difference between a proprietary trading as its defined in terms of the bank taking risks on its own money and providing services to its customers is not only a fine line; it’s a real mixture.

Think of it as how you would look at an insurance policy. When someone’s taking out a whole life policy, are they taking it out for an investment or are they taking it out to hedge themselves against the risk of what happens when the breadwinner in the family passes away? Will there be resources?

The answer is, it’s actually a little bit of a mix of both. And that’s the way it is with providing financial services to businesses.

JEFFREY BROWN: All right, well, this is one of the issues that’s come up, that it’s hard to distinguish…

DENNIS KELLEHER: Right.

JEFFREY BROWN: … between these different kinds of practices.

DENNIS KELLEHER: That’s one of the arguments that’s made, but, frankly, it doesn’t withstand scrutiny.

These are the smartest people in the world, supposedly, making the most money that human beings have ever made in the world. And they’re claiming that they can’t distinguish between activities that are fairly common and have been around for decades, if not hundreds of years.

Proprietary trading, at the end of the day, is one of the handful of the biggest of big banks on Wall Street basically putting their own capital at risk, as opposed to putting their clients’ money at risk or servicing their clients. It’s — they know how to distinguish between those two things. And the law actually — otherwise laws require them to for risk, capital and compliance.

So for them to claim that they can’t distinguish when their own capital is being put at risk and when their clients’ capital is being used frankly is just not accurate. It can’t be accurate. They would be breaking laws left and right all the time if they couldn’t tell the difference between the two.

JEFFREY BROWN: Go ahead.

WAYNE ABERNATHY: Banks clearly can tell the difference between the two. The question is, can the regulators tell the difference between the two? They’re the ones that are going to enforce the rule.

And particularly look at how this rule was put forward. It is five separate regulators creating five identical, but separate rules that will be enforced in five separate ways.

JEFFREY BROWN: So, what do you think is going to happen?

WAYNE ABERNATHY: Your typical bank has two or three or in some cases four of those regulators that are going to interpret that rule. And our concern is, it’s going to make it difficult for the bank to be able to meet the needs of its customers.

And we’re not just talking Wall Street banks. The way the rule is written, it applies to every single bank in America, which, by the way, are under 7,000 today. They were more than 8,000 a few years ago. The last time we were down to 7,000 banks was 1891. We want to turn around that pressure on community banks, midsize banks, let them grow and meet the needs of their customers again.

JEFFREY BROWN: OK. That goes to part of the question. How do you regulate this? Are there going to be discrepancies?

(CROSSTALK)

DENNIS KELLEHER: There are not going to be discrepancies.

The reality is that while the rule is broadly applicable, it’s only going to impact less than the biggest 12 banks on Wall Street. They’re the only one who have the balance sheet and the capital to engage in any material proprietary trading.

JEFFREY BROWN: Can I stop you there? Do you agree with that?

WAYNE ABERNATHY: No, that’s absolutely wrong.

(CROSSTALK)

WAYNE ABERNATHY: I have been in meetings this week with banks of all sizes, from the small community bank of $100 million to the $10 billion bank to the $300 billion bank, and they’re all affected by the Volcker rule.

(CROSSTALK)

JEFFREY BROWN: All right, I interrupted, so go — continue.

DENNIS KELLEHER: There are special — there are special — there are special provisions for community banks and smaller banks that both reduce the burden and make the Volcker rule effectively inapplicable in fact.

And what we have is, we have Wall Street and the biggest banks once again saying the sky is going to fall if they are regulated. Well, the problem is that the sky did fall in 2008. Wall Street got the bonuses; the American people got the bill. Taxpayers back up these banks. That’s why they’re called too big to fail.

Their high-risk trading and investments have to be limited to protect Main Street from Wall Street. And when the big banks pretend to care about economic growth, job creation, and capital formation, well, I will tell you, nothing hurt growth, jobs and capital formation more than the crash of 2008.

And preventing it is one of the most important things to protect those things and Main Street.

JEFFREY BROWN: Well, just in our last couple minutes here, that goes to the larger question, which is the — the culture of Wall Street, because I think a lot behind this is an attempt, a perceived attempt by regulators to change that culture. There’s even a provision here where the CEOs of banks have to sign every year, right, that they — that they have procedures in place for compliance.

Do you sense an actual change in culture?

WAYNE ABERNATHY: Absolutely.

I think what you have is, from banks largest to smallest, there’s a real desire to be able to focus their resources, focus their energies on funding job creation, funding development of the economy, meeting the needs of their customers from families to small businesses to midsize to large businesses.

What the Volcker rule is doing is perhaps in its intention to focus on those kinds of activities. But we have here nearly 1,000 pages of new regulations that, yes, the big banks will be able to figure that out, but how about the midsize banks, how about the smaller banks? They still have to read it. They still are going to be penalized if they don’t comply.

And in their efforts to try to do that, a lot of small and medium-size businesses are going to find it harder to get services.

JEFFREY BROWN: Very briefly on this culture change.

DENNIS KELLEHER: Saying it doesn’t make it true.

The rule is not going to have any material impact on anything outside the biggest of the big. We do need a culture change on Wall Street. We need rules. We need effective regulators. We need people watching Wall Street closely and regulators closely. But we also need a change in the tone at the top.

We need a compliance culture, instead of a gambling culture. And what we have is, Wall Street’s been at war with financial reform. I would hope that they would take the opportunity of Volcker rule to actually embrace financial reform, and let’s have a safer, sounder banking system that really does serve the economy, rather than building up bankers’ bonuses and putting bailouts at the risk of taxpayer funding.

JEFFREY BROWN: All right, Dennis Kelleher, Wayne Abernathy, thank you both very much.

WAYNE ABERNATHY: Thank you very much.

DENNIS KELLEHER: Thank you.