Today, the Senate Committee on Banking, Housing, and Urban Affairs held a hearing regarding the implications of the so called “Volcker rules.” Today’s hearing marks the second of two hearings this week by the Committee on the Obama Administration’s recent proposal to limit the size and scope of banks and other financial institutions. Earlier this week, the Committee held its first hearing on the proposal  

Testifying before the Committee were:

  • Gerald Corrigan, Managing Director, Goldman Sachs
  • Simon Johnson, Ronald A. Kurtz Professor of Entrepreneurship, Sloan School of Management, Massachusetts Institute of Technology
  • John Reed, Retired Chairman, Citigroup
  • Hal Scott, Nomura Professor of International Financial Systems, Harvard Law School
  • Barry L. Zubrow, Executive Vice President, Chief Risk Officer, JPMorgan Chase

Committee Chairman Christopher Dodd (D-CT) raised the issue of the Volcker Rules’ aim to limit the ability of certain financial institutions to engage in proprietary trading. Senator Dodd asked the panel about the likelihood of the Committee being able to effectively define proprietary trading in a clear enough way for financial institutions and their regulators to identify impermissible trading activities. Some members of the panel said that it was possible while others disagreed or predicted that financial institutions will find ways around any specific definition. Senator Dodd asked Mr. Corrigan what would be the impact on Goldman Sachs if it could not engage in proprietary trading. Mr. Corrigan responded that the impact would not be as significant as some people tend to think and estimated that only 10% of Goldman Sachs’ net revenues were derived from proprietary trading. Concerned with the task of specifically defining such terms such as “proprietary trading,” Senator Dodd noted that every good idea has a bad consequence and that he is concerned about the ripple effect the Volcker rules would have.

Senator Richard Shelby (R-AL), the ranking member of the Committee, asked the panel for suggestions regarding a resolution authority. Mr. Zubrow stated that it is important to have a clear regime in which firms can be allowed to fail and in which management and shareholders are eliminated. Senator Shelby asked if the resolution authority should state unambiguously that no firm is “too big to fail,” to which Mr. Zubrow responded in the affirmative.

Mr. Scott raised the issue of financial institution interconnectedness and that regulators should be focused on the interconnectedness of financial institutions as opposed to the total size of a financial institution. He stated that perhaps there should be a requirement for financial institutions to stress test themselves with regulatory oversight to analyze the effect of the failure of another interconnected financial institution. Mr. Corrigan emphasized that unless Congress gets the resolution authority and interconnectedness issues right, it will not be possible to put to rest the notion of “too big to fail.”

Senator Shelby later asked the panel if they believed that regulators currently have the authority limit a firm’s activities if they conclude that its proprietary trading or interconnectedness with other financial institutions is not a safe and sound practice, and, if so, whether the regulators have the will to use such authority. Mr. Corrigan responded that there is no question that the regulators have the power and added that the financial services industry needs an environment where “prompt corrective action becomes a reality rather than a slogan.” Other panel members echoed this sentiment.

Mr. Johnson stated that the Volcker rules are overdue, noting that the cap on the total size of financial institutions should also be redesigned and measured against gross domestic product. he also stated that he is not aware of any evidence that supports the idea that any financial institution should have assets greater than $100 billion.

Mr. Reed also expressed support for the Volcker rules, stating that the Committee should look to compartmentalize the financial services industry. He suggested that a compartmentalized industry would be healthier for the system, although perhaps not healthier for shareholders.