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May 3, 2017, 10:00 a.m. EDT

Why Paul Volcker fears Trump’s push to roll back Dodd-Frank

Former Fed chairman has concerns about plan to junk bank reform law

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By Greg Robb, MarketWatch

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Read: Treasury Secretary Mnuchin tells Senate Volcker rule is too complicated

So how do you simplify it?

You run across here I think a symptom of United States behavior, legal behavior. We’re very lawyer-minded. Everybody is counseled by lawyers and we have a lot of lobbyists and they want everything written down exactly what we can do.

Can you write the regulation in such a way that the intent is very clear? I think the definition of proprietary trading is quite clear. The question is how do you enforce the definition? And I would say: is the board of directors really concerned about this? And are they telling the management “we hold you responsible for the way this is implemented” and does the management say “yes I understand I’m responsible and I’m going to oversee the trading desk in a manner that satisfies me, because I know what a proprietary trade is, and that they are doing right.” And I think the key to the thing is, both that kind of surveillance from on top, but also they should keep a lot of statistics. Now they keep a lot of statistics, any responsible bank is going to have daily statistics on the trading operation and inventory — how old the inventory is and all that stuff. I’ve always thought a common-sense review of the statistics done by sophisticated people using statistical techniques, they will be able to identify whether there is a pattern of proprietary trading. They are not going to be able to make a judgement whether some particular transaction on some particular day was proprietary or not, but if they see a lot of funny-looking transactions, they’ll see it, and then you get after the bank and the bank says “oh you have to define it” and you are back where we are now, and I don’t think it is necessary to be back where we are now.

There is too much nit-picking?

The example I like to make — in a much more simpler area, so much simpler it is almost crude for me to recite this story but I think it is applicable, when I was president of the Federal Reserve Bank of New York, I would hear all these complaints from the banks about this damn truth in lending regulation. “So long, so complicated, such a burden.” So I got down to Washington, called in the Fed staff, and I said “look why don’t we re-write this regulation, make it less than a hundred pages. You ought to be able to do it in 100 pages.” They said “no, no. it is too complicated. What we are talking about is how you define compound interest, and how you apply it in these different guises.” I said: “I know, you think this is not possible, but go ahead and see what you can do in 100 pages.” So they came up with something and I said “ok, let’s put it out for comment.” Every comment we got from a bank was to add to it. We didn’t get one comment saying it was still too complicated. It was “you didn’t take account of the way we advertise it, or what we’re permitted to advertise, or what we’re not permitted to advertise and just how we calculated the rate and under what circumstances will the penalty rate be applied.”

You can’t win.

This is true. It runs through our whole system, [for instance] our accounting system, which is in trouble. It is all rule-bound. And so, the accounting rules get very complicated. Look at your homeowner’s insurance policy — 80 pages long. Mine is, anyway. I don’t know what yours is. And so, we had this conflict in this international accounting system, people were trying to produce international accounting standards, which they have, say, “we don’t really know this degree of detail, leave it up to the accountants to apply.” We got “No, no, we want more detail.” So, it is not unique to the Volcker rule or other aspects of banking regulation.

I’m interested in your ideas to redesign the Washington regulatory framework. You are proposing one prudential regulator.

One supervisory regulator. One hands-on regulator. By coincidence, I was just looking at some old lectures as I am throwing old papers and one of them was directly on this point. The hand-on supervisor should be for everybody but it shouldn’t be the regulation writer which is, by coincidence, what we’ve proposed. It doesn’t make sense having different hands-on supervisors for the same institutions. There are other ways of doing it. The chances of getting action in this area are very limited, but it is interesting that it has been recurrently on the agenda, doesn’t get very far, for 60 years.

The Fed will lose some regulatory power under your plan?

Right, what we proposed was that there be a separate supervisory agency and one way to do this is take the Fed’s vice chairman for supervision, which I kind of invented, but make him the chairman [of the new supervisory agency.] Then you have an automatic liaison with the Fed. And we said, as many people say, in overseeing the whole system, systemically, that sounds like a job for the Federal Reserve. I think it is very hard to separate responsibility for monetary policy with responsibility for the stability of the system. And that’s got a lot of things to be said – how do you define stability – and all the rest, but the Federal Reserve seems to be obviously the agency to be responsible. And they lost part of their grip, to the extent they had it, when there was so much activity outside the banking system. So the idea is do the hands-on supervision in a separate agency – to the extent some of the [other] agencies still exist, they can have membership on that board and probably should have but the Federal Reserve ought to be worried about the whole system. Sometimes the Federal Reserve has been and sometimes it has not been. It depends.

And merge the SEC and the CFTC?

That’s an old one. That’s a demonstration of how difficult it is to do it. Part of it is Congressional fiefdoms. The Agriculture Committee wants to [oversee] CFTC although the agricultural content there is a miniscule part of all the trading that takes place. You know, all of this is not a new subject. Both Barney Frank and Chris Dodd have an interest in it. But they both came to the conclusion, and I think rightfully, that look, we’ve got a big enough piece of legislation and we can’t take this on at the same time.

Read: Futures markets regulator absent from SEC discussion of volatility

Just stepping back, I think our readers want to know. Is the U.S. financial system stable?

A lot of people tell me when I meet them on the street, junior bankers, senior bankers, tell me [the Volcker rule] has had some impact on the culture of my bank. You can say it is a narrow part of the bank. They all say their first priority is their customer. [Proprietary trading] is an activity that is so unlike service to the customer that they think it has dampened some of the energy on the speculator side. To the extent that it is true, that is the real object of the thing.

I want to take advantage of your accumulated wisdom. You’ve been following Wall Street for so long. Has Wall Street always been trying to wiggle out of regulations?

Yes. It’s been a problem since I’ve been at the Federal Reserve, or more so when I was first involved in commercial banking where I was a bit involved in regulatory and other financial policies. And you could see very different attitudes in different banks. I don’t want to name names. Some banks kind of took the view “look if the Federal Reserve or the Congress said this is the rule, ok, we’ll adapt to it.” There is another group that said: “if that’s the rule, how can I get around it.” It’s human nature, I guess.

After the Great Depression, there was the Pecora Commission Report and it seemed like everyone agreed that changes needed to be made. Maybe there hasn’t been the same agreement after the financial crisis?

Look, I was in banking in 1952 and there was no question that the whole experience of depression and war instilled conservative practices in banks. I always remember the intensity which some of the older bankers said “we must not pay bonuses to individual people, it creates the wrong culture in the bank, to think somebody is going to get more money by doing this kind of a deal. I mean, what kind of a deal will they be doing? We must not succumb to the temptation to pay bonuses.” You can’t imagine a bank these days debating that. It just illustrates the change in the environment.

Read: Bank CEOs to testify before panel seeking cause of crisis

One thing you said in your speech that you were worried that some community banks could turn out to be wolves in sheep’s clothing. What did you mean by that? Is it happening now? Is it a trend?

What I had in mind, that comes partly from my experience with savings-and-loan industry in the 1980s when people could get a savings and loan and then they passed a law and said: “savings and loans can do anything.” Boy, that an open invitation to real-estate development and other businesses at the time living off the savings-and-loan license and the small deposit base that they had. And you see incidents in the banking world, where you get a license in North Dakota or South Dakota and you set up a bank to do things you couldn’t do elsewhere. And it doesn’t take a lot of imagination to think some hedge fund would like to buy a small bank. If you just say $2 billion is a community bank, how many hedge funds operators might say “well, I’d like to acquire a $2 billion community bank and I don’t have to keep it capitalized, I don’t have to do anything.” You get the point.

Read: Trump to talk regulations with community bankers

So regulators always have to be vigilant?

I’m afraid that’s right.

Greg Robb is a senior reporter for MarketWatch in Washington. Follow him on Twitter @grobb2000.

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