Paul Volcker Sounds Hopeful On Financial Reform, With Some Warnings As Well

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White House advisor Paul Volcker sounded hopeful Tuesday about the possibility of meaningful financial regulatory reform passing this year. “I do think we have the promising possibility of getting agreement here,” he said during lunchtime address to the Peterson Institute for International Economics. “I feel more optimistic now than I would have a month ago.”

But at the same time, he voiced skepticism about efforts by banking lobbyists to carve out exemptions from regulation that would force transparency on certain types of derivative trading. “Some of that stuff can be very highly profitable. So there is a strong interest in keeping as much out of the trading operations, as much out of the clearinghouse as possible,” he said. “I think we have to fight against that.”

In his prepared remarks, he offered a pointed warning about exemptions for certain types of derivatives, which are contained in both the House version of financial reform and, to a lesser extend, the bill proposed by Sen. Chris Dodd, the Banking Committee chairman. “I am very leery of the pleas of the market to freely permit a large volume of customized derivatives beyond official oversight,” Volcker said. “It seems to me it is precisely those derivatives, highly engineered, highly opaque, that can get us into trouble.”

He also endorsed a White House plan to limit the growth of financial institutions relative to the size of liabilities in total liabilities in the financial system. He said he did not see as realistic proposals to force current mega-banks to shrink their size, though he was not against the idea in principle. “I think we do reasonably well to prevent it from getting more concentrated. That’s just a practical judgment,” he said, after a question from an economist in the audience. “If you can stir up some support for what you are saying, I am probably not going to be in the vanguard but I would be interested in seeing what you can do.”

Volcker’s most substantive contribution to the debate over financial regulation is the so-called “Volcker Rule,” which seeks to restrict the ability of commercial banks, which get preferential treatment from the Federal Reserve, to take risky proprietary bets. The proposal, which was endorsed by Obama in January, is not contained in the House legislation. But it is contained, in a weaker form, in the Dodd bill. His legislation calls for a study of the issue before any rules mandating separation between commercial banking and proprietary trading are written or enforced.