Thursday, February 16, 2012

Paul Volcker Slaps Down Bank of Canada Over Rules to Prevent Banks Too Big to Fail

Simon Johnson, the former chief economist at the International Monetary Fund, is the co-author of “13 Bankers.”

The Volcker Rule is intended to curb “proprietary trading” – specifically, high-risk bets placed by our largest banks. The Dodd-Frank financial reform act put it into law, and the relevant regulators have proposed a detailed and credible set of regulations to make it work. In accordance with typical administrative procedure in the United States, comments on these regulations were solicited. The deadline was this past Monday.

Today’s Economist
Perspectives from expert contributors.

Congress rightly decided that excessive risk-taking by very large banks had to be curtailed. Responsible regulators around the world are cheering from the sidelines, and that’s why I was shocked to see the recent comment letter from the Bank of Canada that criticized the American law.

The legislative intent behind the Volcker Rule is clear – and reaffirmed in detail in the comment letter by Senators Jeff Merkley of Oregon and Carl Levin of Michigan, the co-authors of the relevant part of the Dodd-Frank legislation.

The reason that the general approach and this specific regulation makes sense, given past practices and likely future risks, is laid out in meticulous and convincing detail in the comment submitted by Dennis Kelleher and his colleagues from Better Markets.

The big banks and their allies are naturally fighting back. They like the implicit too-big-to-fail subsidies and are apparently offering to split those with people who will support their positions in public (including some of my academic colleagues). Their collective lack of concern for the public interest is also natural, if somewhat callous.

But the executives of these companies have a fiduciary responsibility to their shareholders to make profits, and they interpret the too-big-to-fail subsidies as helpful in this regard. Government support, after all, allows these banks to borrow more cheaply and to take on more risk (gaining more when they get lucky, precisely because they have “downside protection” provided by taxpayers).

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