Some Surprising Volcker-Rule Haters

If you thought that the Dodd-Frank financial regulations were old news, that banks have been duly regulated, and that we can now move on to other concerns, think again.

As the curtain falls on the comment period for the so-called Volcker Rule, financial companies, legislators, and industry bodies have rushed to get in their two cents. Not surprisingly, big banks have been a key group weighing in. As I outlined yesterday, behemoths like Bank of America (NYS: BAC) , Citigroup, and Goldman Sachs have a lot to lose from the rule, so they're doing their darnedest to play evil dentist on the few teeth that actually remain in it.

But I was surprised to see a concerned comment letter from a group of smaller regional banks including PNC Financial (NYS: PNC) , Regions Financial (NYS: RF) , KeyCorp (NYS: KEY) , and Fifth Third (NAS: FITB) . Their contention? That the Volcker Rule will impose a costly new control and compliance regime on them, even though they're not the banks that should be targeted.

In the letter, the group describes itself as the part of the banking industry whose "primary mission is to serve our local communities" as opposed to "the complex or globally interconnected financial firms that much of Dodd-Frank was intended to address."

Their complaint is that the Volcker Rule doesn't really differentiate and would subject even these smaller regional banks to "many, if not all, of the same requirements applicable to the largest financial firms with substantial trading volume and covered fund investments." The letter continues:

One paramount initial concern is that the proposal would require each of our organizations in extremely short order to develop and implement compliance, internal controls, record-keeping and reporting regimes simply to "prove a negative" that we are not engaged in impermissible proprietary trading or funds activities.

This seems like a legitimate problem. To the extent that regional banks are not, and haven't ever, taken part in the risky activities that we'd like to see taken off the menu at the larger banks, it seems senseless to foist a costly compliance regime on them. For that matter, I can't actually say that I'm in love with the idea of another layer of compliance and rules within the big banks to regulate risky activity. After all, there were already risk departments at all of the big banks prior to the crisis which were supposedly focused on keeping a handle on risky activities, and we know how well that worked out.

The root of the problem
Watching the Volcker Rule develop has been a little like watching the campy classic The Blob. The rule started as a concise three-page letter from former Federal Reserve chief Paul Volcker. Then, it became a 10-page proposal within the Dodd-Frank legislation. By September of last year, it had oozed its way to a 298-page draft legislation, no doubt swallowing up countless low-level regulators and unpaid Washington interns in its wake.

What we've ended up with is really the worst of all worlds. It's so riddled with loopholes -- for market-making, hedging, etc. -- that the savvy, well-staffed "too big to fail" banks should be able to find ways to do pretty much the same things they were doing before. Meanwhile, the complexity will require people, systems, and oversight that will be costly for regulators and banks -- both the big boys as well as the regionals mentioned above.

As the three-page-to-300-page transformation suggests, the current incarnation of the Volcker Rule is far from what its namesake originally had in mind. What Volcker wanted was clear legislation that clearly directed regulators rather than a lot of "exemptions" and regulatory discretion.

At the time that the rule was first being discussed, Volcker's view was that "it's very unlikely that the regulators and supervisors would evoke a strict prohibition until a crisis came and then it's too late ... That's why you want it in legislation." To underscore the point, he added "I've been a regulator for 20 years ... So I know how they are."

And what of the monstrosity that is now being discussed? Instead of a tome that provides more wiggle room than a water weenie warehouse, he still preferred something simpler saying:

I'd write a much simpler bill. I'd love to see a four-page bill that bans proprietary trading and makes the board and chief executive responsible for compliance. And I'd have strong regulators. If the banks didn't comply with the spirit of the bill, they'd go after them.

Is there any hope?
Unfortunately, we don't have Steve McQueen (rest in peace) to help us deal with this legislative blob. We do, of course, have Paul Volcker, who has written a comment letter of his own (opens a PDF) on the rule, addressing, among other things, the silly contention that proprietary trading didn't contribute to the financial meltdown and the seemingly widespread belief in the almighty and always-positive power of liquidity.

We also have Jeff Merkley (D-Ore.) who joined in the commenting process, submitting a letter pushing for a much stronger implementation of the Volcker Rule. Those that have followed the debate may remember that Merkley and Michigan's Carl Levin (D-Mich.) were behind the original Volcker Rule provisions. What is up for discussion today is not what Merkley had in mind, as he bluntly wrote: "[W]e think the Proposed Rule is simply too tepid." He vehemently argues for a much stronger implementation of Volcker's original push, basically saying that these are important changes that need to take place over the chorus of whines from Wall Street:

[N]owhere in the text of the statute nor in the legislative history of the provision is there any direction to regulators that the plain meaning of the statute should be ignored because of the potential impact it might have on the volume of trading in any given market.

We shall see
It was a little surprising to see smaller regional banks wading into the storm of opposition to the Volcker Rule, but I can't help but agree with their concern that the current version of the legislation will impose unnecessarily complex regulations.

In my view, though, the solution boils down to the same conclusion I came to yesterday: We need this important legislation to be made stronger and simpler. I applaud the efforts of Volcker, Merkley, and others to push for exactly that outcome, but with lots of financial might and lobbying power behind the banks, I have the distinct feeling that I'm rooting for a heavy underdog.

At the time thisarticle was published The Motley Fool owns shares of PNC Financial Services Group, Bank of America, Fifth Third Bancorp, Key, and Citigroup. Motley Fool newsletter services have recommended buying shares of Goldman Sachs. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.Fool contributor Matt Koppenheffer owns shares of Bank of America, but does not have a financial interest in any of the other companies mentioned. You can check out what Matt is keeping an eye on by visiting his CAPS portfolio, or you can follow Matt on Twitter @KoppTheFool or Facebook. The Fool's disclosure policy prefers dividends over a sharp stick in the eye.

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