Former Federal Reserve Chairman Paul Volcker called for Congress to "define the business of commercial banks" and set policies to resolve large, complex failing institutions with "euthanasia not a rescue,” in remarks before a Senate panel Tuesday.
Volcker laid out an Obama administration proposal named after the former Fed chair. The "Volcker Rule" would prevent commercial banks from engaging in proprietary trading or in business with hedge funds or private equity funds.
Scroll down to read Volcker's prepared testimony.
According to his prepared remarks, Volcker argues "curbing the proprietary interests of commercial banks is in the interest of fair and open competition as well as protecting the provision of essential financial services."
Volcker, who is also the chairman of President Obama's newly created Economic Recovery Advisory Board, argues new government regulation "needs to be broad enough to encompass efforts sure to come to circumvent the intent of the law. We do not need or want a new breed of bank-based funds that in all but name would function as hedge or equity funds," according to Volcker's prepared remarks.
The former Fed chair believes hedge funds "are, and should be, free to trade, to innovate, to invest – and to fail" according to his testimony.
Volcker will also call for Congress to grant the federal government resolution authority - the government mechanism to take over, unwind and sell off firms becoming too large and interconnected, and whose failure would pose a threat to the broader financial system.
"It is critically important that those institutions, its managers and its creditors, do not assume a public rescue will be forthcoming in time of pressure," said Volcker's prepared statement.
Volcker's remarks also outline "the wide range of potentially profitable services that are within the province of commercial banks," including lending, investment management, and automatic teller machines, among a long list of bank services.
On the "Volcker Rule"
"In itself, that would be a significant measure to reduce risk. However, the first point I want to emphasize is that the proposed restrictions should be understood as a part of the broader effort for structural reform."
" 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."
" What we plainly need are authority and methods to minimize the occurrence of those failures that threaten the basic fabric of financial markets."
"It is critically important that those institutions, its managers and its creditors, do not assume a public rescue will be forthcoming in time of pressure. To make that credible, there is a clear need for a new “resolution authority ... The mandate is to arrange an orderly liquidation or merger. In other words, euthanasia not a rescue.”
" Apart from the very limited number of such “systemically significant” non-bank institutions, there are literally thousands of hedge funds, private equity funds, and other private financial institutions actively competing in the capital markets. They are typically financed with substantial equity provided by their partners or by other sophisticated investors. They are, and should be, free to trade, to innovate, to invest – and to fail."
" ... the functional definition of hedge funds and private equity funds that commercial banks would be forbidden to own or sponsor is not difficult. As with any new regulatory approach, authority provided to the appropriate supervisory agency should be carefully specified. It also needs to be broad enough to encompass efforts sure to come to circumvent the intent of the law. We do not need or want a new breed of bank-based funds that in all but name would function as hedge or equity funds."
" My understanding is that only a handful of large commercial banks – maybe four or five in the United States and perhaps a couple of dozen worldwide – are now engaged in this activity (prop trading) in volume. In the past, they have sometimes explicitly labeled a trading affiliate or division as “proprietary”, with the connotation that the activity is, or should be, insulated from customer relations.
"For instance, patterns of exceptionally large gains and losses over a period of time in the “trading book” should raise an examiner’s eyebrows. Persisting over time, the result should be not just raised eyebrows but substantially raised capital requirements."
"... proprietary trading activity should not be able to profit from knowledge of customer trades."
"... neither am I so naïve as to think that, even with the best efforts of boards and management, so-called Chinese
Walls can remain impermeable against the pressures to seek maximum profit and personal remuneration."
" ... it may be useful to remind you of the wide range of potentially profitable services that are within the province of commercial banks.
-- First of all, basic payments services, local, national and worldwide, ranging from the now ubiquitous automatic teller machines to highly sophisticated cash balance management;
-- Safe and liquid depository facilities, including especially deposits contractually payable on demand;
--Credit for individuals, governments and businesses, large and small, including credit guarantees and originating and securitizing mortgages or other credits under appropriate conditions;
--Analogous to commercial lending, underwriting of corporate and government securities, with related market making;
--Brokerage accounts for individuals and businesses, including “prime brokerage” for independent hedge and equity funds;
-- Investment management and investment advisory services, including “Funds of Funds” providing customers with access to independent hedge or equity funds;
--Trust and estate planning and administration;
--Custody and safekeeping arrangements for securities and valuables."
"What we can do, what we should do, is recognize that curbing the proprietary interests of commercial banks is in the interest of fair and open competition as well as protecting the provision of essential financial services."