December 9, 2013

The Volcker Rule Isn't the Best Way to Prevent Risky Bank Trading  

Hester Peirce

Former Senior Research Fellow
Summary

Federal financial regulators are getting set to vote on the long-awaited Volcker rule, a key part of the Dodd-Frank financial reform law that aims to prohibit banks relying on deposit insurance from engaging in risky trading activities. In the words of the provision's authors, it reflects the view "that high-risk, conflict-ridden trading should not be subsidized by taxpayer insured deposits and cheap credit from the Federal Reserve."

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Federal financial regulators are getting set to vote on the long-awaited Volcker rule, a key part of the Dodd-Frank financial reform law that aims to prohibit banks relying on deposit insurance from engaging in risky trading activities. In the words of the provision's authors, it reflects the view "that high-risk, conflict-ridden trading should not be subsidized by taxpayer insured deposits and cheap credit from the Federal Reserve."

That laudable goal must be assessed in light of the provision's unintended consequences and its administrative complexities. Policymakers have other options that could address the issue of taxpayer-subsidized risk-taking more effectively than the Volcker rule will.

Lawmakers included the Volcker rule in Dodd-Frank based on rhetoric rather than careful deliberation. Proprietary trades were not a significant cause of the financial crisis. More importantly, it is not clear that prohibiting firms from trading will make them safer.

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