The Securities and Exchange Commission has just released a detailed Report to Congress examining trends in financial market activity since the implementation of the Volcker Rule. Since this report was requested by Congress in September 2015, before the November elections, it cannot be interpreted as a direct commentary on any specific proposal advanced by the Trump Administration. Nevertheless, the SEC’s report does cite and discuss another recent document, released in June by the U.S. Treasury, that argues for a number of changes to the financial regulatory system, including modifications to the Volcker Rule.
Although the SEC’s report might be seen at first glance as casting doubt on whether the Treasury’s proposed changes are really needed, a more careful reading of the 315-page document points to a different conclusion: we simply do not know enough, yet, to say definitively whether the Volcker Rule has helped or hurt and, by extension, whether modifications will or will not make things better. The authors of the SEC’s study deserve credit for highlighting this scientific conclusion. Indirectly, their analysis reinforces important points made long ago by Friedrich Hayek and Milton Friedman, who argued that government officials almost always lack the detailed information that would allow their own interventions to improve upon free-market outcomes.
The Volcker Rule, which is the SEC report’s main focus, was part of the more sweeping 2010 Dodd-Frank legislation. Briefly, the Volcker Rule prohibits banks from engaging in securities investment and trading activities. Its overall intent is to limit institutions that enjoy access to federal deposit insurance and the Federal Reserve’s lender-of-last resort facility to more traditional banking activities, such as accepting deposits and making loans.
The SEC study asks whether imposition of the Volcker Rule has had a negative effect on the functioning of securities markets. Do the restrictions appear to have reduced the volume of stocks and bonds issued by American corporations? Do the restrictions appear to have reduced the liquidity of securities trading in secondary markets? To answer both questions, analysts at the SEC assemble and present vast amounts of data. They observe that dollar volumes of new stocks and bonds issued recently, under the Volcker Rule, are no lower than they were before the financial crisis, when the Rule was not in place. They also find that figures on market liquidity send a more mixed message, with some measures higher and others lower than they were before the crisis.
What this detailed analysis shows is that the Volcker Rule’s effects on securities issuance and trading are not so overwhelmingly large to be immediately apparent in obvious trends over time. Indeed, the authors of the SEC study are careful to emphasize that their analysis does not prove or disprove that the Volcker Rule has had important effects on financial markets. The basic problem underlying SEC study is the multitude of other changes that have accompanied the 2010 regulatory changes.
For example, interest rates are lower, and the economy is healthier. Funds managers at many financial institutions continue to be more risk averse than they were before the financial crisis; on the other hand, important technological changes may be allowing them to trade more efficiently. It is extremely difficult to disentangle the effects of all these other factors from those of the Volcker Rule itself. As a result it is complicated to answer the more crucial question in evaluating the Volcker Rule: how much higher or lower would security issuance and liquidity be today under the counterfactual without the Volcker Rule than they are today with the Volcker Rule in place? While the data, by themselves, do not show that the Volcker Rule has curtailed or inhibited trading activity in securities markets, they do not show, either, that the Volcker rule has not had those negative consequences.
The authors of the SEC report deserve much credit for resisting the pressure and temptation they may have felt to come down more strongly in support of or against the Volcker Rule. They deserve credit for emphasizing, instead, the scientific uncertainty that remains despite all their hard work. Although their study does not mention Friedrich Hayek or Milton Friedman, it does provide yet another example of how, as both Hayek and Friedman emphasized, limitations on our knowledge of how the economy works also place limitations on policymakers’ ability to use detailed regulations to achieve outcomes that improve on those offered by more freely-functioning markets.
The new Congress and President Trump should accept this point as their main take-away from the SEC study. Instead of trying to micromanage every possible bank activity, they should design rules that are clear and simple, and that work by holding bank managers and shareholders personally accountable for losses incurred by taking on too much risk.
Peter Ireland is a professor of economics at Boston College and a member of the Shadow Open Market Committee.
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