How to Best Combat Systemic Risk
By Michael Leonidas Nester
This Note examines the Dodd-Frank Act’s ban on proprietary trading and on banks sponsoring hedge funds and private equity funds, known as the Volcker Rule. This Rule has been a point of contention since the Act was passed in 2010. Some argue that the ban is either a detriment to bond market liquidity or is unnecessary because a tenuous nexus exists between proprietary trading and true causes of the 2008 financial crisis. Proponents cite the role of proprietary trading in the crisis and the inherent risk that banks accept when engaging in such trading. The controversy surrounding the Volcker Rule has led individuals in politics and finance to discuss whether to amend, or even repeal, the Rule.
This Note explores arguments for and against the Volcker Rule and ultimately offers recommendations to amend the Rule while maintaining its (and Dodd-Frank’s) venerable goal of curbing systemic risk. First, this Note begins with a discussion of the causes of the financial crisis and systemic risk before explaining the Rule’s provisions. This background provides the groundwork for the ongoing debate about the Volcker Rule and whether there should be a change in the language of the Rule. Proponents and opponents have clashed on multiple issues, such as whether proprietary trading played a significant role in the financial crisis and whether it actually reduces systemic risk. Understanding arguments on both sides is crucial to assess whether and how the Volcker Rule should be amended in light of systemic risk. This Note concludes that neither outright repeal of the Rule nor leaving it fully intact are appropriate. Rather, this Note offers recommendations to amend it in a way that balances banks’ desires to engage in profitable trading with the global interest in curbing systemic risk in the financial system.