Volcker: Derivatives rule goes too far; banks shouldn't have to shed businesses

By Brady Dennis
Washington Post Staff Writer
Saturday, May 8, 2010

Count former Federal Reserve chairman Paul Volcker among those concerned about a contentious proposal that could force big banks to spin off their lucrative derivatives businesses.

In a letter to senators from both parties, Volcker said commercial banks providing derivatives to customers "in the usual course of a banking relationship" shouldn't be banned from that practice. Volcker's stance is significant not just because of his role as a White House economic adviser, but because he has pushed to prohibit banks from making risky trades on their own accounts and still favors such limits.

The controversial provision by Senate Agriculture Committee chairwoman Sen. Blanche Lincoln (D-Ark.) takes that notion a step further, seeking to keep derivatives trading outside of federally insured banks.

Derivatives are contracts that allow traders to bet on the direction of prices of stocks, commodities and other assets. Companies often use them to manage risk by locking in prices for goods, such as oil, that fluctuate in value. Derivatives account for hundreds of trillions of dollars in deals and helped fuel the panic that swept the world in 2008, in part because of rampant speculation and a lack of transparency in the market.

Volcker's letter echoes a diverse set of critics who have argued that Lincoln's measure goes too far. They include other Obama administration officials, financial industry groups, top banking regulators and lawmakers from both sides of the aisle.

A trio of Senate Republicans -- Judd Gregg (N.H.), Bob Corker (Tenn.) and Saxby Chambliss (Ga.) -- this week offered an amendment to the financial overhaul legislation pending in the Senate that would strike the section forbidding the Federal Reserve and Federal Deposit Insurance Corp. from providing federal assistance to banks that have major derivatives operations.

"This is an ill-thought-out idea," Gregg said recently, describing the section he hopes to strike. "Not only would it push a lot of business offshore, it would contract credit on Main Street significantly."

Lincoln and her supporters have remained steadfast that such a measure is necessary.

"Under our current system, there are a handful of big banks that are simply no longer acting like banks," she said on the Senate floor this week. "Banks were never intended to perform these activities, which have been the single largest factor to these institutions growing so large that taxpayers had no choice but to bail them out in order to prevent total economic ruin."

She has pushed back on the notion that her provision would harm Main Street companies that use derivatives simply to hedge their business costs, rather than for speculating. She also rejected criticism that the measure would harm U.S. competitiveness and lead to less regulation by forcing derivatives operations into more opaque markets overseas.

In a statement, Lincoln expressed respect for Volcker and said she agreed with his proposals to ban banks from certain risky trading activities.

"Absent my provision, however, we have not done enough to address the massive size of entities that became so large that taxpayers were left with no option but to bail them out," she said. "My provision begins to cut down the size of these institutions by moving this risky activity into fully regulated entities, protecting American taxpayers."

It remained unclear Friday when or if the Senate would take up the Gregg-Corker-Chambliss amendment. No further votes on changes to the bill are expected until Tuesday.

Republicans also have offered their own version of legislation to oversee the derivatives trade.

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