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Too Big To Fail: The Volcker Rule or Glass Steagall?

by Elaine Schwartz    •    Mar 16, 2013    •    816 Views

It will be tough to remedy “too big to fail” with the Volcker Rule. At the other extreme, some suggest a 2013 version of Glass-Steagall. Here is the short version of the facts:

Proposed by former Fed Chair Paul Volcker, his rule was expressed in 10 pages of the Dodd Frank Wall Street Reform and Consumer Protection Act. Essentially the Volcker Rule said that banks could no longer engage in proprietary trading for their own account because it created too much risk.

But, what does proprietary trading mean? We can start with the trading that former and current Chase executives described to the Senate Investigations Subcommittee during testimony yesterday. Here is just one graph that displays the magnitude of their proprietary trading of indescribably complex financial products. Do remember that you need to add 6 zeroes to the numbers along the y-axis.

Here, the scale is massive--hundred's of millions of dollars.

With much more detail, the FDIC/SEC/Treasury/Federal Reserve also tried to explain proprietary trading. They needed 298 pages, 1300 questions and 400 topics.

Responding, former banker Henry Kaufman took a different path.

“Paul Volcker and I are the same age [84]. Paul wanted to take an aspect of risk-taking out of the financial conglomerates. That’s a worthy endeavor. But the history of regulation shows that the private sector pushes back and waters it down. Dodd-Frank didn’t want to address the longer-term consequences of ‘too big to fail.’ The 10 largest banks held 10 percent of the assets in 1990; today they control over 70 percent. This trend accelerated in 2008. The ‘too big to fail’ got even bigger.”

He continued, “My view is that we should break up the big financial conglomerates and separate investment banking. Otherwise we’re going to have ongoing government intervention in the credit allocation process. That threatens economic democracy, and the U.S. is the last bastion of economic democracy.”

Sounds like Glass Steagall.

A 34 page 1933 law, Glass-Steagall separated investment and commercial banking, changed the structure of the Federal Reserve and created the FDIC. J.P. Morgan knew, for example, that it had to divide itself into a commercial bank and an investment bank. 2 entirely separately owned firms, Morgan Guaranty, a commercial bank and Morgan Stanley, an investment bank were the result.

And now, we are back to where we started.

Sources and Resources: For primary sources, here is a lengthy description of the Volcker Rule while here is the 34 page Glass Steagall Act. For interpretation, this 2011 NY Times column discusses the Volcker Rule’s implications and the Henry Kaufman response. Finally, to see more about yesterday’s testimony, here is the Committee document and here is a WSJ article (the source of the above graph).

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