WASHINGTON — When the White House first announced a plan to ban banks from proprietary trading in January, reaction from both political parties made it appear dead on arrival.
Yet, to the surprise of the industry representatives, the so-called Volcker Rule has persisted in the Senate's version of regulatory reform, even if doubts about its effectiveness also persist.
What remains to be seen is how dedicated the White House and Banking Committee Chairman Chris Dodd are to pushing the issue. Some see it as little more than a political bargaining mechanism.
"I don't think it will wind up in the final version of the Senate bill," said Brian Gardner, an analyst with KBW Inc. "Including it was a negotiating tactic. It's a piece Dodd can bargain away when the Senate … gets back into negotiations with Republicans. Volcker is another chip he can cash in and give up."
But observers have underestimated policymakers' enthusiasm for the idea in the past.
When the White House announced the plan, days after the Democrats' defeat in the Massachusetts Senate race, many saw it as little more than a political stunt. Sen. Richard Shelby, R-Ala., said it was "airdropped" by the White House and had complicated bipartisan negotiations in the Senate, while lawmakers from both parties criticized the administration's vague definition of proprietary trading.
"There was doubt up front whether it would even make it into the legislation," said Gregory Lyons, a partner at Debevoise & Plimpton LLP. "Sen. Dodd himself raised both procedural and substantive concerns. The fact that it's in there in and of itself is noteworthy."
Dodd ultimately opted to include it in his regulatory reform bill, even while leaving most of the heavy lifting to the banking agencies — and kicking any potential effect from the rules years into the future.
Under the legislation, the ban on proprietary trading and restrictions on investments with hedge funds and private equity would not go into effect until after a proposed interagency council completed a study that defines proprietary trading and weighs in on how implementing the new rules would affect the safety and soundness of banks. Regulators would then have 15 months to set final rules based on the council's recommendations. Once the rules were implemented, banks would have two years to comply and to sever ties with trading, hedge funds and private equity.
Though it would be years before banks would have to comply with the rules, Lyons said their effect could still be "traumatic" for some institutions.
Many banks would need to face a range of issues that "go all the way from adjusting ownership [in private-equity funds and hedge funds] to, in the most extreme case, disposing of a bank to move out from under the Bank Holding Company Act," he said.
But regulators argue that the Senate should keep the provisions, and that they are essential to the long-term stability of the financial system.
"The reason you get into bailouts in this recent set of circumstances is the intermixing of banking and investment banking," Kansas City Federal Reserve Bank President Thomas Hoenig said in an interview. "We will still have big institutions. … But we'll have more manageable risk, and more ability to deal with these institutions if we separate them out under the Volcker rule or something similar."
Others argue that a ban could leave domestic banks at a large disadvantage to foreign ones, and that proprietary trading was not a factor in the financial crisis.
"That's going way too far," said Robert Clarke, senior partner at Bracewell & Giuliani LLP and a former comptroller of the currency. "One day someone will wake up and say we've really made banks noncompetitive with foreign banks." But Hoenig says not to act is to miss a valuable opportunity.
"If the proprietary trading was not the cause, then I'd say they were lucky, or that the other problems got them first," he said. "To not have a strong rule of law for resolution, for the Volcker Rule, is to invite a repeat of this crisis, only it will be larger next time … the American taxpayer has and will again pay the bigger price."