Paul Volcker has long been regarded as a giant in the financial services industry, and with good reason. He was likely most influential during his tenure as Chairman of the Federal Reserve during both the Carter and Reagan administrations, when he played a leading role in bringing down the rampant levels of inflation at the time. A generation later, he returned to the spotlight as chair of the Economic Recovery Advisory Board, a post he retained until early in 2011. His storied history also includes stints with the New York Fed and the Treasury Department, along with senior posts in the private sector at institutions such as what was then Chase Manhattan and investment banking firm Wolfensohn & Co.
In 2014, his name will probably be in the headlines again quite a bit, even if he personally doesn’t say much. That’s because right before Christmas, the American Bankers Association (ABA) announced plans to file a lawsuit challenging key portions of what is generally known as the Volcker Rule, a set of regulations that prevents many banks from speculatively trading with their deposits.
There are many interesting aspects to this developing imbroglio, not the least of which is that the ABA is leading the fight on behalf of smaller institutions, which it says are already concerned over possible repercussions. The harm to these vulnerable companies is described as “real, imminent, and irreparable.”
Of course, no one expects the challenge to end there. Some of the issues covered by the Volcker Rule, such as collateralized debt obligations (CDOs)—which are widely blamed for helping stoke the financial crisis of the last decade—are deeply embedded in the business practices of much larger corporations. If the new rules are not amended, it’s easy to see how many of these Fortune 100 conglomerates might throw themselves into the legal fray.
For the record, it’s far from clear exactly how these regulations will affect the industry, and it’s a matter of interpretation whether the Volcker Rule even prohibits banks from holding CDOs. However, many observers insist that it does exactly that, and some auditors are saying that without further guidance from the Fed (along with the FDIC and the Office of the Comptroller of the Currency, both of which are also named in the potential lawsuit), banks would be well advised write down CDOs, even if it means taking a hit to the balance sheet.
The regulations and potential lawsuits, while new, are in no way a surprise. There’s been intense lobbying behind the scenes for a long time now, but it was only in December that five federal agencies approved the final rule. That’s still left plenty of room for loopholes, hence the ongoing concerns and legal challenges. Besides, banks still have a solid six months to drop the questionable assets from their portfolios, and can subsequently apply for an extension. In other words, these are early skirmishes that help set the stage for more sustained assaults.
There’s also a broader question here that deserves attention. To many, Volcker represents a different breed of financial services veteran, a point he demonstrated during his appearance before a British parliamentary commission a year ago. “The economic and social value of much of the trading and innovative financial engineering is questionable,” he stated forcefully, adding that without regulation banks will inevitably intertwine trades for their own accounts with their retail businesses—a toxic brew by any definition. In this and other appearances, Mr. Volcker has voiced criticism of new financial instruments that disrupted long-held industry processes and practices.
As we noted on this blog at the time, those are exactly the characteristics that sustain and nourish the technology industry. Is there are way for the disruptive innovation of the tech world to be balanced with the stability required in financial services? As these legal challenges play out, we might get some interesting answers to that question.