The Volcker rule, then and now

Paul Volcker has long been regarded as a giant in the financial services industry, and with good reason. He was likely most influential during his tenure as Chairman of the Federal Reserve during both the Carter and Reagan administrations, when he played a leading role in bringing down the rampant levels of inflation at the time. A generation later, he returned to the spotlight as chair of the Economic Recovery Advisory Board, a post he retained until early in 2011. His storied history also includes stints with the New York Fed and the Treasury Department, along with senior posts in the private sector at institutions such as what was then Chase Manhattan and investment banking firm Wolfensohn & Co.

In 2014, his name will probably be in the headlines again quite a bit, even if he personally doesn’t say much. That’s because right before Christmas, the American Bankers Association (ABA) announced plans to file a lawsuitchallenging key portions of what is generally known as the Volcker Rule, a set of regulations that prevents many banks from speculatively trading with their deposits.

There are many interesting aspects to this developing imbroglio, not the least of which is that the ABA is leading the fight on behalf of smaller institutions, which it says are already concerned over possible repercussions. The harm to these vulnerable companies is described as “real, imminent, and irreparable.”

Of course, no one expects the challenge to end there. Some of the issues covered by the Volcker Rule, such as collateralized debt obligations (CDOs)—which are widely blamed for helping stoke the financial crisis of the last decade—are deeply embedded in the business practices of much larger corporations. If the new rules are not amended, it’s easy to see how many of these Fortune 100 conglomerates might throw themselves into the legal fray.

For the record, it’s far from clear exactly how these regulations will affect the industry, and it’s a matter of interpretation whether the Volcker Rule even prohibits banks from holding CDOs. However, many observers insist that it does exactly that, and some auditors are saying that without further guidance from the Fed (along with the FDIC and the Office of the Comptroller of the Currency, both of which are also named in the potential lawsuit), banks would be well advised write down CDOs, even if it means taking a hit to the balance sheet.

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