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Bending the Volcker Rule

As Federal Reserve chairman, Paul Volcker inherited double-digit inflation and an American economy struggling for growth. He led the charge to hike interest rates and keep them up in order to squeeze inflation out of the economy.
As Federal Reserve chairman, Paul Volcker inherited double-digit inflation and an American economy struggling for growth. He led the charge to hike interest rates and keep them up in order to squeeze inflation out of the economy. TNS file| July 2, 2014

Paul Volcker is credited with taming runaway inflation, helping seed the U.S. economy for the booming 1980s and ’90s. He is an imposing figure in finance, and that has nothing to do with his 6-feet-7 frame.

As Federal Reserve chairman, he inherited double-digit inflation and an American economy struggling for growth. He led the charge to hike interest rates and keep them up in order to squeeze inflation out of the economy.

Volcker’s focus on inflation was a sea change for the central bank. It carries over to today’s Federal Reserve.

His second most notable contribution to American finance bears his name: the Volcker Rule. Its fate with today’s Fed isn’t as secure. In the week ahead, the Fed’s Board of Governors meets Wednesday to discuss changing the rule.

The Volcker Rule was born out of the Great Recession and the desire to curtail risks taken by banks. It bans banks from using customer deposits, which are backed by deposit insurance, for short-term trades in all kinds of things for the banks’ own benefit. It also prohibits banks from owning hedge funds or private equity funds.

Volcker was the architect of the idea after big banks lost big money from making big trades, leveraging customers’ money. It was a landmark shift meant to make banking boring again.

The effort to do away with the rule has been underway since before it even went into effect — less than three years ago. Bank lobbyists were successful in delaying the provisions for years.

The rule won’t be erased — that would take an act of Congress — but it is likely to be eased. Trading for their own benefit meant big profits for banks in the years before the rule. And the tangle of regulations is costly. Critics of the rule say relaxing it for community banks will encourage investment by freeing up money banks otherwise can't touch or have to spend on following it.

Volcker’s lesson to fight inflation remains intact. His rule to limit bank trading activity won’t be.

Tom Hudson hosts “The Sunshine Economy” on WLRN-FM; @HudsonsView.

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