The Volcker Rule

How a Simple Idea to Rein In Banks Got Supersized


Merriam-Webster’s Dictionary defines “speculation” in 31 words. The key ones are “risk of a large loss.” When Paul Volcker, the former U.S. Federal Reserve chairman,  in January 2009 proposed banning speculation by federally insured banks to reduce risk to the world economy, he did it in one paragraph. Four years later, the nation’s regulators issued a final rule based on Volcker’s proposal. It ran close to 100 pages, with hundreds more in supporting material — and no one was quite sure how it would be enforced. While that was being figured out, still more paper piled up in bank lawsuits challenging parts of the rule and in lobbying drives for regulatory tweaks and extensions. By the time the rule finally took effect in July 2015, it had become a lesson in how complicated simplifying Wall Street can be.

The Situation

Even as drafts of the rule was being fought over, many banks shut down the desks they used for trades that were solely for their own account, what’s known as proprietary trading. Banks do other kinds of trading that can also make them money, or lose it. One involves the steady stream of securities banks buy, sell and hold so their customers can always buy what they want to buy and sell what they want to sell, an activity called market-making. Another involves trades to offset the risks of a bank’s own transactions, known as hedging. The rule approved in December 2013 was more lenient on market-making and tougher on hedging than was originally proposed:  Regulators had grown wary after JPMorgan Chase’s $6.2 billion London Whale loss, which many saw as closer to gambling than to a hedge. Since the rule was announced, banks have been divesting themselves of some trading units or holdings in private equity funds and lobbying , often successfully, for extensions. Republican victories in the 2014 midterms increased bankers’ eagerness to push for larger changes, although the first effort by House Republicans fell short. More lobbying lay ahead, and in October 2015 Democratic presidential candidate Hillary Clinton proposed measures to strengthen the rule. In the European Union, regulators hope to put their own, even narrower rules in place — by 2020.

Source: Bloomberg
Source: Bloomberg

The Background

After the Great Depression, Congress created federal deposit insurance to prevent runs at commercial banks. In return, the banks had to concentrate on making loans while leaving the fancy stuff to investment banks. That dividing line blurred in the ’90s and was erased entirely in 1999 when the Glass-Steagall Act was repealed at the behest of banks like Citigroup that promptly grew big trading operations. The financial crisis of 2008 had its seeds in bad mortgages, but what brought banks to the brink, Volcker noted when he proposed his idea, wasn’t bad loans but the exotic trades they had made around them. The six largest U.S. banks made $15.6 billion in trading profits during 13 of the 18 quarters that spanned mid-2006 to 2010. They racked up bigger losses during the five remaining quarters when their bets turned sour. Even after the meltdown and unpopular taxpayer bailouts, taking a step back toward Glass-Steagall met Wall Street resistance. That’s why when President Barack Obama adopted the idea he wrapped it in Volcker’s name, in the hope that the towering stature of the man who tamed 1970s inflation would lend it greater weight. The idea became law in the Dodd-Frank reforms of 2010, but the rule-writing took another three years.

The Argument

Even after the Volcker rule regulations were release, many on Wall Street continued to insist that it would prove unworkable. Distinguishing between different categories of trades and assessing appropriate risks is either impossible or highly subjective, they say. Jamie Dimon, the chief executive officer of JPMorgan Chase, said in 2012 that every trader would need a psychologist and a lawyer by his side to make sure he wasn’t breaking the rule. Volcker responded that the rule could accommodate a range of trading and still stay fairly simple. “It’s like pornography,” Volcker said of prop trades. “You know it when you see it.”  Instead of blanket bans, however, regulators sought to define each situation and carve out a string of exemptions, which is how the rule grew and grew. A small band of bipartisan voices in Washington continued to say they would rather push for a more radical simplification — bringing back Glass-Steagall — if the Volcker rule proves tougher on paper than in practice. For the most part, by the time the rule took effect many in the investment world seemed to have learned to live with it, though some wondered if new risks had been created in the effort to stamp out old ones.

The Reference Shelf

  • Davis Polk’s Volcker rule website has the final rule text and statements from the various agencies.
  • Volcker’s original proposal to the Group of 30.
  •  A summary of the 2010 Dodd-Frank Act.
  •  In 2010, Volcker voiced dissatisfaction with the regulations being developed.
  • Volcker’s comment letter on the joint proposal.
  • An interactive timeline on the rule’s development by American Banker.

First Published Dec. 10, 2013

To contact the writer of this QuickTake:

Yalman Onaran in New York at

To contact the editor responsible for this QuickTake:

John O'Neil at