Simon Johnson: Will There Be a Meaningful Volcker Rule? Simon Johnson is the Ronald A. Kurtz Professor of Entrepreneurship at the M.I.T. Sloan School of Management and co-author of "White House Burning: The Founding Fathers, Our National Debt, and Why It Matters to You." The Dodd-Frank financial reform legislation of 2010 stipulates that banks and the corporate entities that own banks should get out of the business of "proprietary trading." That term refers to investments, often highly risky, that very big banks got into the habit making on their own account, i.e., unrelated to anything that their customers asked them to do. Such bets have the potential to break a bank, creating either an unacceptable liability for taxpayers or a serious risk to the financial system, or both. They also often put these megabanks in the conflicted position of betting against their customers. The regulators involved in drawing up the rules to carry out Dodd-Frank include the Federal Reserve's Board of Governors, the Federal Deposit Insurance Corporation, the Commodity Futures Trading Commission, the Office of the Comptroller of the Currency and the Securities and Exchange Commission. They have still not been able to complete the rules, in part because, as with anything to do with modern finance, the details are complex. The draft regulations and explanations run 116 pages in the Federal Register. The C.F.T.C. held a roundtable on those current draft rules on May 31; I've taken part in many discussions on financial reform in the last four years, and this was one of the best. The commission invited some leading experts on financial reform, individually and collectively with a great deal of practical experience - and skeptical of big banks" ability to manage their risk-taking appropriately. Yet I remain pessimistic that regulators will adopt a strong final Volcker Rule in the near term, partly because of recent disclosures about the efforts of Senator Scott Brown, Republican of Massachusetts, to blunt the impact of the rule, and what these activities tell us about the November elections. At one level, the tone and content of the exchange at the roundtable were very encouraging. Sheila Bair, former chairwoman of the Federal Deposit Insurance Corporation, led off the discussion with a clear and powerful statement - banks should not be able to use government-guaranteed deposits as a basis for speculation. Any bank with insured deposits receives, in effect, a subsidy - and in return it must behave responsibly. This set the theme for the day, which broadened to include the various ways in which global megabanks receive subsidies by being too big to fail. When things go well, executives and traders at these banks receive the upside. When they are unlucky - or when their risk management systems break down - and downside risk materializes, it is someone else's problem. Some of the country's largest banks originally planned to attend the roundtable, but, according to published news reports, they pulled out after JPMorgan Chase's unexpected multibillion-dollar trading losses were disclosed. The elephants were therefore not in the room. But they were well represented by lawyers appearing on behalf of two industry associations, the International Swaps and Derivatives Association and the Securities Industry and Financial Markets Association. A consulting company, IHS, also discussed a report it had prepared for Morgan Stanley. And there were other organizations present that take the side of American megabanks (as well as Credit Suisse and Barclays, which are Swiss and British, respectively, but which perceive themselves as sharing some of the same interests). The big banks" wing of the debate displayed a fascinating degree of resistance to the notion that they receive large implicit taxpayer subsidies. They had three main counterarguments. The first line of reasoning is that the Dodd-Frank financial reforms "ended too-big-to-fail," a patently false assertion about the current situation. It is true that under Title II of Dodd-Frank, the F.D.I.C. is in charge of preparing ways to liquidate systemically important financial institutions without causing systemwide distress or panic. But this mechanism is not yet in place and, even if it were, substantial technical and political difficulties would remain. I'm on the F.D.I.C."s Systemic Resolution Advisory Panel and I support its efforts, but this will be a long slog. When pressed, no one in the room seemed to think that JPMorgan Chase or any other behemoth could really fail - implying losses for their creditors - any time soon. The second counterargument is that we need the biggest American banks at their current scale and scope, because otherwise "liquidity" in markets will dry up (in this context, liquidity refers to the ability of market participants to buy and sell particular securities, preferably without moving the price much). The notion is that only the megabanks can provide the necessary market-making, particularly in debt and associated derivatives - thus allowing nonfinancial companies to finance themselves and hedge their operational risks. John Parsons, my colleague at the Massachusetts Institute of Technology and an expert on derivatives, including their use by nonfinancial companies, pointed out the fundamental flaw in this reasoning. If a market-making activity is truly valuable and big banks are really unable to provide this service because of the Volcker Rule, someone else will step up - and make money through filling a genuine customer need. This is how markets work. A blog post by Professor Parsons also demolishes the logic behind the IHS report on this issue. Lynn Stout of Cornell University made the important point that liquidity per se is not necessarily a good thing. The road to financial crisis is littered with forms of debt that were considered highly liquid until they weren't - think of Greek sovereign debt or complex American mortgage-backed securities and their derivatives. Artificially pumping up market liquidity through too-big-to-fail subsidies to market makers is not a good idea. Along the same lines, allowing big banks to speculate wildly under the guise of hedging their risks is not a good idea. With more details now surfacing about how big risks were taken and mismanaged at JPMorgan Chase, this argument is currently being played down by the industry. The third argument was the strangest: industry representatives and their allies do not see the subsidies; therefore they do not exist. Marc Jarsulic of Better Markets pointed out in plain English that the big advantage is in lowering the overall funding costs for bank holding companies. Exactly how sophisticated financial-sector analysts can refuse to comprehend this notion is beyond understanding. JPMorgan Chase and similar scale organizations can borrow more cheaply because creditors believe there is downside protection provided by some combination of the Federal Reserve and the Treasury. Yes, I know that the emergency powers of the Federal Reserve were changed - some would say curtailed - by Dodd-Frank. It is no longer so easy to provide support to an individual financial entity, as was done for A.I.G. in September 2008. But I've also spent a great deal of time discussing the details of this issue in the last two years, with both private-sector and government experts (some at the Fed, others not) - and the simple fact remains that the Fed can devise means of support when needed, more easily to banks but probably to any entity whose imminent collapse is deemed to pose a risk to the financial system. The markets correctly perceive this to be the case. Any other position you hear from officials is simply a form of denial - and should be seen as a great source of concern. The credit of the Treasury and the financial firepower of our central bank effectively support the credit of JPMorgan Chase (and the other too-big-to-fail entities). This is what it means to have an implicit government guarantee - a point discussed at the roundtable with Gary Gensler, the C.F.T.C. chairman, during one of his very effective interventions on Thursday. Over all, the roundtable went about as well as it could for people who want big banks effectively excluded from proprietary trading. Frankly, however, I don't think executives at big banks will lose much sleep over what happened at the meeting. Their strongest game is not in the public debate but behind closed doors. They will no doubt release another torrent of comment letters, designed to slow the implementation of the Volcker Rule further. If you are inclined to push the other way, comment letters are still being accepted; I recommend matching the industry in terms of length and details. A link on the C.F.T.C."s Web site allows individuals to submit comments on the Volcker Rule until June 22. Knowledgeable former industry participants could usefully supplement letters by requesting meetings with officials and arguing their points directly; the team at Occupy the S.E.C. has done this ably. Dennis Kelleher's organization, Better Markets, has also been most effective. The megabank strategy is to delay as much as possible until after the November election, while pouring money into the campaigns of Republicans who would like to roll back the Volcker Rule or even repeal Dodd-Frank entirely. The Boston Globe reported this week that a senior staff member for Senator Scott Brown has been pushing for a relaxation of crucial Dodd-Frank provisions, particularly with regard to how big banks are allowed to invest in various off-balance-sheet funds. Remember that Citigroup, for example, largely blew itself up in 2007-8 through such investments. In my assessment, as I told The Globe, these recommendations or requests would substantially undermine the effective constraints intended by the Volcker Rule. Senator Brown continues to present himself as a financial reformer while taking very large contributions from Wall Street (which may well increase after the Globe article). This dissonance may well become the prevailing theme of the November elections. President Obama missed his chance to reform the financial system by breaking up the largest half-dozen banks - making them small enough and simple enough to fail. On many specific points, he listened to those in the White House and the Treasury who advised him to do relatively little with regard to the megabanks. "Don't do too much" was the theme, particularly during the Senate debate on limiting the scale and scope of our biggest banks. Now the very big banks and their executives are contributing to Mitt Romney in his campaign against President Obama and are concentrating resources against anyone who wants to reform the financial system (or keep in place what limited reforms we have). The targets include Elizabeth Warren, the Democratic candidate opposing Senator Brown. This issue will not be decided in a C.F.T.C. conference room, through interagency deliberation or even by the thousands of pages of industry-sponsored comment letters that will drown the regulators. The outcome for the Volcker Rule will ultimately be decided in an election in which there are no effective constraints on campaign spending by special interests - and the megabanks will outspend everyone. Candidates who do the bidding of big banks will present themselves as financial reformers and spend a great deal on television advertisements to persuade the electorate that this is so. Watch Senator Brown's campaign closely for details.