Paul Volcker, former Chairman of the Federal Reserve Board and current Chairman of the President’s Economic Recovery Advisory Board, spoke before the Senate Committee on Banking, Housing, and Urban Affairs on February 2 regarding President Barack Obama’s so-called “Volcker Rule” proposal. The Volcker Rule would prohibit a bank or bank holding company from owning, investing in, or sponsoring hedge funds or private equity funds, or engaging in proprietary trading operations for its own profit unrelated to serving its customers. Volker specifically addressed three questions that have arisen about the proposal. First, on the issue of international consensus on the proposed approach, he expressed his belief that there were substantial grounds to anticipate success as the approach was more fully understood. Second, he felt that the functional definition of hedge funds and private equity funds that commercial banks would be forbidden to own, sponsor or invest in, and proprietary trading in which they would be forbidden to engage, would not be overly difficult to delineate. Third, he highlighted the strong conflicts of interest inherent in the participation of commercial banking organizations in proprietary or private investment activity. Volcker remarked, “Hedge funds, private equity funds, and trading activities unrelated to customer needs and continuing banking relationships should stand on their own, without the subsidies implied by public support for depository institutions.”
Volcker emphasized that the proposed restrictions were part of a broader effort for structural reform to help deal with the problem of “too big to fail” and the related moral hazard. To ensure that large institutions and their managers and creditors do not assume a public rescue will be forthcoming in times of pressure, Volcker expressed support for the proposed House bill that provides authority to a designated agency to intervene and take control of major financial institutions to avoid their collapse. However, according to Volcker, non-“systemically significant” non-bank institutions, such as hedge funds, private equity funds, and other private institutions, should be allowed to fail in a competitive free enterprise system.