Wednesday, May 19, 2010

Merkley-Levin Amendment

We have reached endgame. We know the rough contours, at least, of the financial-regulatory reform that will become law this year. See the particulars here.

Among the tweaks pending, there is an amendment on offer from Sens. Carl Levin, D-Mich., and Jeff Merkley, D-Ore., that would re-work the “Volcker Rule,” Paul Volcker's brainstorm re keeping banks from using their deposits for nasty speculative purposes. This is the rule that would prohibit banks from sponsoring hedge funds or from running their own proprietary trading operations.

The Volcker Rule is section 619 in the Dodd bill, S. 3217. The key point is that the only way to ban prop trading is to distinguish between prop trading on the one hand and market making on the other. The Dodd bill simply took it as a given that legislation can't do this effectively, and left that detailed distinction to the regulators. Subject to "such restrictions as the Federal banking agencies may determine," the buying or selling of securities "as part of market making activities, or otherwise in connection with or in facilitation of customer relationships," is not proprietary trading and thus is not banned. Those Federal banking agencies will presumably "know it when they see it" as a Supreme Court Justice once said in another context.

Levin and Merkley aren't satisfied with this, and their language would attempt to take some discretion away from the federal banking agencies. They, too, have a generic "market maker" exception, which they word so as to exclude from prop trading "the purchase, sale, acquisition, or disposition of securities and other instruments ... in connection with underwriting, market making, or in facilitation of customer relationships, to the extent that any such activities permitted by this subparagraph are designed to not exceed the reasonably expected near term demands of clients, customers, or counterparties."

Which means ... what? For an argument to the effect that this is a loosening of Dodd's version of the rule posing as a toughening-up thereof see The Economics of Contempt, an excellent blog in general and a worthy posting on this subject in particular.

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