There’s been a lot of discussion recently about the Volcker rule in the popular press, and how it’s going to be implemented. Most prominently, Michael Lewis wrote a widely-read column last week about how the banks are simply shifting their prop trading to market-making desks. While I’ve said before that the poorly-drafted language of the Volcker rule will make it very difficult to enforce effectively for precisely this reason, Lewis’ column is an absolute disaster. Lewis badly misstates the law, identifies the wrong loophole (which is amazing, since there are so many actual loopholes), and generally demonstrates no understanding of the issue whatsoever.

Lewis claims that the loophole is the bill’s definition of proprietary trading as investing “as a principal.” He then goes on to claim that the government agency who must “determine precisely what the phrase means” is....the Government Accountability Office!

First of all, the GAO has absolutely nothing to do with it. The GAO doesn’t write banking regulations. It’s the Fed’s job to write the Volcker-rule regulations for the big banks. The GAO just has to do a study on proprietary trading sometime in the next 12 months, which is completely separate from the rulemaking process for the Volcker rule. Hence why the GAO spokesman clearly had no idea what Lewis was talking about when he called. (The FSOC also has to do a study on prop trading, which actually is part of the rulemaking process for the Volcker rule. Don’t ask.)

Second, the phrase “as a principal” isn’t a even loophole. Everyone understands that both proprietary and market-making trades are entered into “as a principal,” and no one has a problem with that. (That is, after all, what a market-maker does.) There’s no need for banks to try to pretend like they’re not entering into trades “as a principal,” because trading as a principal isn’t prohibited! What’s prohibied is trading as a principal “for the purpose of selling in the near term (or otherwise with the intent to resell in order to profit from short-term price movements).” If Lewis doesn’t understand this much, then he really has no business writing multiple columns about the Volcker rule.


Anonymous said...

Looks like Volcker has a key allay in the Bank of England Governor. This makes devastating reading...

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Can someone please explain to me what the Volcker rule is? i'm lost...

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