AEI's Wallison: Why the Volcker rule would not have prevented the JP Morgan Chase losses

In a just-published post, AEI financial services expert Peter Wallison argues that the Volker rule would not have prevented JP Morgan Chase's losses (full text below).

"[W]hat happened at JPMC is proof that the Volcker rule is unworkable and should be abandoned....The rule bans proprietary trading by banks, but specifically authorizes hedging transactions. It appears from news reports that JPMC was suffered the losses while pursuing a hedging strategy. If so, the losses would not have been prevented by the Volcker rule."

Peter Wallison is available via email at [email protected] or though Veronique Rodman, [email protected] or 202.862.4871.
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JP Morgan's losses prove that the Volcker rule is unworkable
Peter Wallison

Much of the commentary about the JP Morgan Chase losses suggests that either this is proof of the need for the Volcker rule, or is a reason to get the Volcker rule in place promptly. Neither is true. In fact, as thus far reported, what happened at JPMC is proof that the Volcker rule is unworkable and should be abandoned.

The rule bans proprietary trading by banks, but specifically authorizes hedging transactions. It appears from news reports that JPMC has suffered the losses while pursuing a hedging strategy. If so, the losses would not have been prevented by the Volcker rule.

More broadly, it is virtually impossible to determine whether a specific trade or a series of trades is a hedging transaction--an effort to reduce risk that the bank has already taken on--or speculation, a risk that the bank is taking. That is the fundamental flaw in the Volcker rule, and the reason why it should be repealed.

If the answer cannot be determined except by knowing all the circumstances surrounding a trade, and what was in the mind of the trader when the trade was put on, it is not suitable for a regulation--i.e., for a written rule like the Volcker rule. Instead, it is suitable for a subsequent supervisory action; an investigation by a bank supervisor to determine the facts after the event, which may then result in a penalty for the bank if it has failed to comply with the distinction between speculation and hedging.

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