A conservative Volcker Rule
The GOP needs a broader, tougher financial-reform agenda.

Reuters

Former U.S. Federal Reserve Chairman Paul Volcker listens to comments during a panel discussion, on how the current financial crisis has changed the role of central banks, at the National Press Club in Washington, Oct. 11, 2010.

Article Highlights

  • Republicans don’t like the Volcker rule, but they need an alternative financial-reform agenda

    Tweet This

  • Reining in Fannie, Freddie, and Feddie is an incomplete, although ideologically comfortable, financial-reform agenda for the GOP.

    Tweet This

Republicans generally don’t like the now-adopted Volcker rule, which prevents banks with federally insured deposits from trading for their own profit — or much else about the Dodd-Frank financial-reform law, for that matter. Recall that Mitt Romney pledged to repeal the whole magilla if he became president. Romney didn’t win, of course, and it’s no more likely that President Obama would ever sign a repeal of Dodd-Frank than it is that he would repeal the Affordable Care Act.

But that doesn’t mean Republicans don’t need an alternative financial-reform agenda, especially considering that the U.S. has averaged a financial crisis every half-dozen years the past few decades. So far for the GOP, it’s pretty much been about the three “Fs”: Fannie, Freddie, and “Feddie” — to prevent future bubbles, shutter the two government mortgage giants and shackle the U.S. central bank.

Yet it’s hard to see what that approach does to reform a Too Big to Fail financial system of growing size, concentration, and complexity. As analysis from the Dallas Fed recently pointed out, fewer than a dozen megabanks — just 0.2 percent of all banking organizations — control two-thirds of the assets in the U.S. banking industry. And if international accounting rules — which count a wider range of derivatives — were applied to U.S. banks, over half of all bank assets would be held by just three institutions: JPMorgan Chase, Bank of America, and Citigroup. These megabanks, as Dallas Fed president Richard Fisher puts it, are each capable “through a series of missteps by their management of seriously damaging the vitality, resilience, and prosperity that has personified the U.S. economy.”

That was true before Dodd-Frank, and it’s still true today. There is no reason to think that the next time a megabank finds itself in a financial pinch, government won’t find a way to come riding to the rescue in the name of systemic stability and panic prevention. “The history of big bank failure is a history of the state blinking before private creditors,” notes the Bank of England’s Andrew Haldane. But extraordinary measures by scared lawmakers may not even be necessary: Dodd-Frank allows a failed megabank, through the law’s “orderly liquidation authority,” to be kept alive for years by special U.S. Treasury financing.

There are several options that reform-minded Republicans and Democrats should consider. FDIC director and former Kansas City Fed president Thomas Hoenig has proposed a sort of super Volcker rule, which would ban banks with FDIC-insured deposits from any sort of trading or market-making, as well from owning complex securities such as the collateralized debt obligations that played a starring role in the financial crisis. Banks would be limited to well-understood activities such as commercial lending, asset management, and stock and bond underwriting. Banks would become smaller, simpler, and blessedly boring.

The Dallas Fed’s Fisher is also in favor of downsizing the megabanks and would add two additional provisions. First, limit the federal safety net — deposit insurance and the Federal Reserve’s discount window — to traditional commercial banks only. Their parent companies and non-bank affiliates would be excluded. Second, customers, creditors, and counterparties of all non-bank affiliates would have to sign a simple form acknowledging there is no federal backstop available to them.

Finally, banks should be required to finance their lending with far more shareholder equity, as opposed to money borrowed from creditors. This is how it worked in the pre-deposit-insurance era of the 19th and early 20th centuries. As Anat Admati and Martin Hellwig argue in The Bankers’ New Clothes: What’s Wrong With Banking and What to Do About It, requiring banks to have an equity cushion “on the order of 20–30 percent of their total assets would make the financial system substantially safer and healthier.”

Reining in Fannie, Freddie, and Feddie is an incomplete, although ideologically comfortable, financial-reform agenda for the GOP. Next year would a good time to add ending Too Big to Fail to that list.

— James Pethokoukis, a columnist, blogs for the American Enterprise Institute.

Also Visit
AEIdeas Blog The American Magazine
About the Author

 

James
Pethokoukis

What's new on AEI

To secure southern border, US must lead international effort to stabilize Central America
image The Ryan pro-work, anti-poverty plan: Thomas Aquinas 1, Ayn Rand 0
image Does SNAP support work? Yes and no
image Obama Democrats lose their big bet on health exchanges
AEI on Facebook
Events Calendar
  • 21
    MON
  • 22
    TUE
  • 23
    WED
  • 24
    THU
  • 25
    FRI
Monday, July 21, 2014 | 9:15 a.m. – 11:30 a.m.
Closing the gaps in health outcomes: Alternative paths forward

Please join us for a broader exploration of targeted interventions that provide real promise for reducing health disparities, limiting or delaying the onset of chronic health conditions, and improving the performance of the US health care system.

Monday, July 21, 2014 | 4:00 p.m. – 5:30 p.m.
Comprehending comprehensive universities

Join us for a panel discussion that seeks to comprehend the comprehensives and to determine the role these schools play in the nation’s college completion agenda.

Tuesday, July 22, 2014 | 8:50 a.m. – 12:00 p.m.
Who governs the Internet? A conversation on securing the multistakeholder process

Please join AEI’s Center for Internet, Communications, and Technology Policy for a conference to address key steps we can take, as members of the global community, to maintain a free Internet.

Thursday, July 24, 2014 | 9:00 a.m. – 10:00 a.m.
Expanding opportunity in America: A conversation with House Budget Committee Chairman Paul Ryan

Please join us as House Budget Committee Chairman Paul Ryan (R-WI) unveils a new set of policy reforms aimed at reducing poverty and increasing upward mobility throughout America.

Thursday, July 24, 2014 | 6:00 p.m. – 7:15 p.m.
Is it time to end the Export-Import Bank?

We welcome you to join us at AEI as POLITICO’s Ben White moderates a lively debate between Tim Carney, one of the bank’s fiercest critics, and Tony Fratto, one of the agency’s staunchest defenders.

Event Registration is Closed
No events scheduled this day.
No events scheduled this day.
No events scheduled today.
No events scheduled this day.
No events scheduled this day.