Critical Mass: why US Treasury swallowed unloved Volcker rule  

Bank prop trading ban drafted in a lunch break after Democrat defeat in Massachusetts

  • The Volcker rule was a late addition to Dodd-Frank, proposed by the White House for largely “political” purposes after the House bill had already been passed.
  • The Volcker rule was hated by US Treasury, but the Democratic Senate loss in the January 2010 Massachusetts special election suddenly made the rule attractive.
  • The loss of the Democrats’ Senate supermajority allowed left-wing senators to force the Obama administration to insert the bank proprietary trading ban in exchange for their votes.
  • A Treasury staffer was instructed to come up with two to three pages of legislative text, which would become the Volcker rule base text, in just a couple of hours.
  • Banks and regulators are still grappling with how to identify trader intent under the Volcker rule today, due to amendments by left-wing senators to make it even tougher on banks.   

This is the second in a series of two articles focusing on the Volcker rule. The first article on efforts to reform or repeal the rule is available here.

A rumour has haunted the halls of the US Treasury building for the past seven years. It is a murky tale from the recent past, half-whispered by today’s young department staffers, unsure of its veracity and even less sure of whether they should be repeating it. 

It is a story about narrow political goals contaminating the legislative process and the passage of a law for the purposes of expedience rather than financial stability. It is a tale to which Treasury Secretary Steven Mnuchin alluded at an event in Washington, DC on April 20.

“I don’t think the Volcker rule had anything to do with the financial crisis. I think it was more of a political issue than it was necessarily a problem during the crisis,” Mnuchin said.

This is the story of the unlikely political circumstances that gave rise to what is now one of the most contentious aspects of the Dodd-Frank Act. Although an old yarn, it is being told here for the first time.

The account that follows is based on more than a dozen interviews with former Treasury staffers, senatorial assistants, Federal Reserve staff and Paul Volcker himself.  For many of the principals involved – who have spoken to both on the record and anonymously – this is the first time they have agreed to talk about the extraordinary confluence of events that took place in Washington during the first months of 2010, which led to the passage of the Volcker rule.

A diplomatic reception

Not many pieces of financial regulation receive the honour of a White House press conference to announce their proposal, but that is precisely how the Volcker rule started life.

The date was January 21, 2010, a year and one day into the Obama administration. Reporters gathered in the Diplomatic Reception Room were told by the president that two new elements were to be inserted into the financial regulatory reform legislative process: a ban on proprietary trading by bank holding companies, and a prohibition on banks sponsoring or investing in hedge funds or private equity firms – henceforth to be known as the Volcker rule.

Everything about the announcement was odd. For one thing, the House of Representatives had passed its own version of the financial reform bill five weeks earlier, with no comparable language included within it.

For another, the White House had never taken such a public hand in directing the federal government’s response to the financial crisis; the Treasury Department had been the lead agency on the issue since the earliest days of the administration.

Finally, there were the events that took place in Massachusetts on the previous evening. In a stunning upset, Republican Scott Brown pulled off an unlikely victory in defeating Democrat Martha Coakley to win the late Edward Kennedy’s seat in the US Senate – a seat the Democrats had held continuously since it was won by John F. Kennedy in 1953.

Paul Volcker

Brown’s victory was more than merely embarrassing; it had the potential to be catastrophic for Obama’s entire legislative agenda during his first term. Brown had handed the Republicans a crucial 41st seat in the Senate, gifting the party enough votes to filibuster legislation proposed by the Democrats who until then had held a supermajority in the upper chamber.

Now, the afternoon following this seismic shift in the Senate, the White House was proposing to add two new and unprecedented restrictions on banks that were certain to delight a Democratic base hungry to make Wall Street suffer for the economic disaster it had unleashed on the country 18 months earlier.

Even to fellow Democrats, the announcement reeked of political calculation. Chris Dodd, then-chairman of the Senate Committee on Banking and Urban Affairs, summed up these suspicions just over a week later during a hearing on the Volcker rule on February 2: “While I’ve certainly been familiar with the issue of dealing with proprietary trading, it does come up late. And the idea that the administration made this such a major point a week or so ago seemed to many to be transparently political and not substantive.”

Paul Volcker, architect of the proprietary trading ban, appearing before the committee that day, sought to dispel suspicions of there being a political motive behind the eleventh-hour introduction of his eponymous rule.

“The idea that this comes down to some party vote or 60 votes, I don’t think is right. I read all this stuff that the president’s announcement was political – it came after Massachusetts. I know, personally, he decided this some weeks before and he’d been discussing what day to announce it long before Massachusetts. It was just a sheer coincidence that this thing came out on Thursday after Massachusetts,” Volcker insisted.

The truth was far from that clear-cut. President Obama had indeed endorsed and supported the prop trading ban prior to the events in Massachusetts, but it was far from coincidental that the Volcker rule was announced the day after the election. 

It was just a sheer coincidence that this thing came out on Thursday after Massachusetts
Paul Volcker

“It all came back to Scott Brown. The Democrats needed 60 votes to get the financial reform bill out of the Senate and they could not afford to let any of the left fall away, and that is why instead of veering to the right after Massachusetts, they veered hard left,” says Don Lamson, a lawyer who spent 30 years at the Office of the Comptroller of the Currency (OCC) and was seconded to the Treasury Department to assist in the passage of Dodd-Frank.

“The Democrats knew Martha Coakley was a lost cause long before the vote, and while politicians may be poor on substance they are very good on politics. The calculations were already being made on where the weaknesses may be in the Democratic coalition, and individual senators like Jeff Merkley and Carl Levin were trying to figure out what they might be able to get out of the situation. They came out for what ultimately turned into the Volcker rule – they wanted a ban on proprietary trading,” Lamson adds.

In short, the presence of the Volcker rule in the US statute book today can be largely attributed to a political calculation made in the wake of a temporary electoral reversal. The story of the Volcker rule itself, however, began over a year earlier during the worst days of the financial collapse.

A czar is born

Shortly after his election victory in November 2008, Barack Obama announced the establishment of the President’s Economic Recovery Advisory Board (Perab) and named former Federal Reserve head Paul Volcker as its chairman.

Volcker had already been spearheading unofficial efforts to address the burgeoning financial calamity through the G30, an international body comprised of policymakers, regulators, bankers and academics. By the time he was appointed head of the Perab, he was already well into writing an 82-page report, encapsulating the G30’s conclusions. It was in this document, published in January 2009, that the prototype Volcker rule was first enunciated.

“Large, systemically important banking institutions should be restricted in undertaking proprietary activities that present particularly high risks and serious conflicts of interest. Sponsorship and management of commingled private pools of capital (that is, hedge and private equity funds in which the banking institutions’ own capital is commingled with client funds) should ordinarily be prohibited, and large proprietary trading should be limited by strict capital and liquidity requirements,” Volcker wrote in the G30 report.

Volcker used his new position as chairman of the Perab to counsel President Obama to include the two measures among the reforms under consideration by both the Treasury Department and the National Economic Council (NEC). The only problem was that Treasury secretary Tim Geithner and NEC chairman Larry Summers hated both ideas.

Like with any idea, there were a mixture of views about it [and] there was a lack of clarity on whether there was sufficient support for it internally to move forward
A senior Treasury official

“Unenthusiastic” is how Volcker succinctly characterises the response of the two men to the proposal. Geithner and Summers felt the rule was politically toxic – that it would hand the banking lobby a cause célèbre to rally behind in their efforts to defeat the entire package of reforms.

Volcker, his former special assistant Tony Dowd, and Lamson all recount that Treasury and the NEC were not receptive to the prop trading ban in 2009. The first signs of support from the White House did not emerge until December of that year, when it was already becoming clear the Democrats were facing defeat in Massachusetts.

As a result, when the Treasury Department released its white paper outlining what the executive branch would like to see in the financial reform bill, the Volcker rule was not among the proposals.“The discussion on the prop trading ban began in Spring 2009. Like with any idea, there were a mixture of views about it [and] there was a lack of clarity on whether there was sufficient support for it internally to move forward,” says a senior Treasury official from the time. 

Consequently, when the House Committee on Financial Services, led by chairman Barney Frank, drafted its financial reform bill, it did not include a proprietary trading ban or limitations on bank investments in covered funds. The House of Representatives passed the Frank bill on December 11, 2009, without containing Volcker’s measures. To the world, it looked like the matter had been settled.

Biden intervenes

The rule’s unlikely resurrection started with a post-House vote phone call to Volcker from vice-president Joe Biden to enquire how he was getting on with promoting the prop trading ban. Volcker responded that he didn’t have any horses behind the rule and he needed one. Biden replied that he would be that horse.

“Within an hour or so, [chief economist and economic adviser to the vice-president] Jared Bernstein had called and we started working on the first memo describing chairman Volcker’s proposed restrictions on prop trading by banks,” says Dowd, then Volcker’s special assistant.

“We sent that memo down to Jared on December 22, and chairman Volcker met on Christmas Eve in Larry Summers’ office with secretary Geithner to discuss it. Right after Christmas, Bernstein called and he wanted to understand how this proposal would fit into overall financial reform, and we wrote a second memo, which we sent down right before New Year’s Eve. About a week later, we got a call from Summers’ office, saying they were going to send up a draft proposed piece of legislation on what would later be called the Volcker rule,” Dowd recalls.

Tim Geithner

The Damascene conversion of Geithner and Summers from opponents of Volcker to disciples was abrupt and virtually unprecedented. A Treasury staffer says it is extremely rare to see the White House attempt to insert controversial and politically explosive new elements into a bill for consideration before the Senate after the passage of the House’s counterpart bill.

Nonetheless, the senior Treasury official attests it was the passage of the House bill that emboldened the White House to push for more ambitious reforms in the Senate language.  

“I was worried our approach might play into the hands of people who said we should not be regulating non-banks. But once we won the political debate about that point in late 2009, when we got the bill out of the House, I think everybody felt a little bit more comfortable that we could refine the rules for bank holding companies (BHCs) in the Senate bill without losing the larger political fight that we should be able to regulate the likes of Lehman Brothers and AIG, even though they are not BHCs,” says the staffer.

Lunch is for wimps

Other staffers present an alternative account. On January 7, 2010, Brown took the lead in the Massachusetts polls for the first time – 48% to 47% – and thereafter, he retained a narrow lead in almost all subsequent polls.

As the likelihood of Coakley’s defeat and the loss of the Democratic supermajority grew more apparent, the previously unenthusiastic Treasury Department suddenly began to take a keen interest in the proprietary trading ban that Paul Volcker had been promoting for almost a year.

“I was sitting in [assistant Treasury secretary] Neal Wolin’s office one day in early January with a group working on the financial reform bill when Wolin rushes in. He says that with two weeks left to the election in Massachusetts, Martha Coakley is running behind,” recalls the OCC’s Lamson, who was seconded to the Treasury Department at the time.

The connective tissue between the Volcker rule and the Massachusetts election ran through the left wing of the Democratic Party back in 2010. Three of the most left-wing Senate Democrats were threatening to withhold their support for the financial reform bill unless the language was significantly strengthened to be more punitive on banks.

The three senators were Maria Cantwell, Carl Levin and Jeff Merkley. Their threatened opposition held little force in late 2009, because the Senate leadership was counting on the votes of moderate Republicans Olympia Snowe and Susan Collins to pass the bill. The leadership was also counting on two affirmative votes from Massachusetts, however. With Brown’s victory, the Republicans would have the necessary seats to filibuster the Senate bill and scupper financial reform legislation entirely.

The votes of at least two of the three Democrats were now essential. Merkley and Levin had been strong supporters of the notion of prohibiting the ability of banks to operate proprietary trading desks. Suddenly, the Volcker rule was important again.

As a result of this new political necessity, the prop trading ban, which had been bandied around for almost a year, needed to be hastily put into legislative language. The OCC’s Lamson was the person called upon to do the job.

The instructions were very clear: come up with a complete separation of commercial banking and proprietary trading… by 3pm
Don Lamson, formerly of the OCC

“I was about to go to lunch and [Treasury assistant secretary for financial institutions] Michael Barr came in. He was leading the legislative drafting effort. Barr told me to come up with no more than two or three pages of legislative text that would, in effect, prevent banks from engaging in proprietary trading activity. The instructions were very clear: come up with a complete separation of commercial banking and proprietary trading. I was shocked and asked him when he needed it by. He said by 3pm,” Lamson recalls.

Barr’s initial instruction contained no exemption for banks to hold proprietary positions in US Treasuries, according to Lamson. He proposed the already explosive proposal must include a carve-out for Treasuries, which Barr briefly considered and then agreed to.  

“Those three pages basically said ‘henceforth you can’t engage in proprietary trading as defined below’, followed by a definition and then the exception for trading in government securities. Then Barr went off with those pages up to Capitol Hill and that is how the Volcker rule was born,” says Lamson.

Barr disputes this account of events. In a written statement, he insists the Treasury Department’s work on the Volcker rule long predated the election in Massachusetts.

“The Volcker rule proposal was developed over many months, from initial policy discussions to legislative drafting to negotiations with Congress. It was extensively vetted within the executive branch, including by both senior officials and career government lawyers. It was extensively debated in Congress, resulting in a set of amendments that are reflected in the final version of the Dodd-Frank Act. Whether one agrees or disagrees with the policy, it can hardly be said that it was hastily considered,” Barr writes.

Yet the recollections of Volcker himself, and of former assistant Dowd, both partially support Lamson’s version of events. In fact, Dowd sees a direct link between the special election and the administration’s sudden rejuvenated interest in the Volcker rule.

“That sounds right because the whole Scott Brown thing got everybody in a tizzy. Before that, in the fall [autumn], we started meeting with the Senate Banking Committee. There were a lot of conversations going on in the Senate about chairman Volcker’s ideas, which is possibly where the vice-president picked it up,” says Dowd. 

“Sometime around January 7-8, we got the call that they wanted to go ahead with the Volcker rule and the administration was going to send us some draft language. That is when Neal Wolin got involved.”

Wolin did not respond to repeated requests for comment on this story.

Dowd’s diary notation that the green light on the Volcker rule was given at the end of the first week in January accords with Lamson’s account of Wolin’s agitation over Coakley’s poor poll performance and Barr’s instruction to draft some legislative text on a prop trading ban.

Senate takes up Volcker

Events now began to move quickly as the Treasury attempted to flesh out the early Volcker rule text into something more substantive before the Senate Banking Committee began its work on drafting its financial reform bill. Although senators were aware of the prop trading ban concept and President Obama’s prior interest in it, the idea was understood to be a non-starter among senatorial staff due to the opposition of the Treasury Department and NEC.

“We heard nothing more about it until January 2010. It looked like it was political. I think what people thought was that Scott Brown won the election and then the very next day the President held a press conference with Paul Volcker, Chris Dodd and Barney Frank at the White House to announce a new policy called the Volcker rule. I can tell you that Dodd got an invitation to it pretty last minute – it wasn’t an invitation that was sent out two weeks beforehand,” says a former staffer on the Senate Banking Committee.

The staffer relates that Obama assured Dodd that senators would be receiving legislative language on the Volcker rule in the next few days. That didn’t happen, however. By the time Volcker and Wolin testified before the Senate Banking Committee on February 2, the legislators were still impatiently awaiting the language from Treasury.

The frustration of the senators over the delay was made manifest by Dodd, who barked at the witnesses: “It’s adding to the problem of trying to get a bill done. There is only so much this institution will tolerate at any given point in time. So if you have any more ideas, let me know them, and let me know them in a timely fashion.”

I met with Merkley’s staff and they did not think the proprietary trading ban went far enough. I asked them whether they understood how trading works
A Treasury staffer

Once the Senate took up the work of developing the bill, the Volcker rule was duly inserted into the base text of the banking committee draft. Senators Merkley and Levin were both intent on strengthening the most onerous provisions of the bill. Levin, now retired from the Senate and in private law practice in Michigan, declined to be interviewed on the substance of the amendments offered. Calls to Senator Merkley’s office were not returned.

“I met with Merkley’s staff and they did not think the proprietary trading ban went far enough,” recalls one Treasury staffer. “I asked them whether they understood how trading works, and proprietary trading in particular, but after a couple of conversations there was no point in talking to them because they were theologians on the point.”

This account is corroborated by the Senate Banking Committee staffer, who relates that “once the Volcker language came out, both Merkley and Levin started working on it in earnest to try and tighten it up, compared with what had come over from the administration”.

Once the Volcker rule passed the banking committee largely intact, amendment efforts continued on the Senate floor, but Republican objections prevented Merkley and Levin’s rider strengthening the prop trading bill language from coming to a vote.

Decorating the tree

As the Dodd bill progressed through the Senate, the Volcker rule became, in the words of the Treasury staffer, a “Christmas tree” on which amendment after amendment was hung. After the exception for US Treasuries, exemptions followed for agency, state and municipal debt, holdings in small business investment companies and conduct exceptions for acting as an agent, broker, custodian, trustee or fiduciary on behalf of customers.

The Treasury staffer relates that by the time he left the Treasury Department, the various drafts and redrafts of the Volcker rule language filled a four-draw filing cabinet.

While Senate deliberations continued, Lamson recalls the Treasury staff leading the Dodd-Frank effort held a meeting in late spring to review the bill for consistency between the individual titles and sections. It was the first time anyone at Treasury had attempted to gain a panoramic view over how the entire piece of legislation fitted together. 

“We held a meeting off-site. Everybody involved had a current draft of the entire bill and we went page-by-page trying to figure out how one section of the bill interrelated to the next. The aim was to see if we had anything in there that was internally inconsistent and required correction. Nobody had thought about that,” says Lamson.

“But even that didn’t happen. We got about a third of the way through the bill by 4pm and then we never met again. That means there was never a concerted effort to see the interrelationship of these provisions and how the Volcker rule would work in relation to everything else,” he adds.

The senior Treasury official refutes this account. “We did have an all-day session where we did not get through the whole bill, but that was not the only time we worked through the bill to see how that hung together. We were basically doing that every week. At the conclusion of every day we were tracking where we were on various pieces of the bill and what the problems were,” he says.

Carl Levin

Following the passage of the Dodd bill by the Senate, the Volcker rule underwent one final frenetic period of additions, amendments and corrections during the final hours of the marathon conference committee to reconcile the House and Senate financial reform bills in the early hours of June 24, 2010.

Having seen their amendment thwarted during Senate consideration, staff for senators Merkley and Levin were intent on using the conference process to see their proposal inserted into the final reconciled text of the bill. It was at this stage that the issue of trader intent, which has proved a scourge in the attempts to turn the prop trading ban into a workable rule, first appeared.

“The Merkley and Levin amendments wanted to make sure that if we permitted market-making, that should not be seen as an excuse for prop trading. That is where the idea about the intent of the trader was introduced and that any short-term trading should be done for a client rather than for the furtherance of the prop trading goals of the firm. There was strengthening of that provision, but then people became worried about the strengthening, so then they included carve-outs, and then carve-outs to the carve-outs. It got complicated,” says the senior Treasury official.

The evolution of the rule’s complexity can be seen in the progression of the Dodd-Frank language. Section 619 in the Senate markup runs to only 287 lines, but by the time it appeared in the final law, the Volcker rule ran to more than 11 pages. Among the numerous additions made to the text was a definition of the term ‘trading account’, which for the first time introduced the concept of “the intent to resell in order to profit from short-term price movements”.

This seemingly innocuous addition would have major consequences down the road, as regulators and bank compliance officers continued to grapple with the question of trader intent and how to empirically demonstrate a trade was – or was not – entered into for proprietary purposes. 

An uncertain future

Almost seven years on from the events of that night, the Volcker rule is under siege. Federal Reserve governors – current and outgoing – have decried its complexity and called for a radical overhaul of the implementing rule. They may soon get their wish.

On April 20, Mnuchin confirmed he is leading an effort through the Financial Stability Oversight Council to revise, rather than repeal, the Volcker rule. The regulation that emerges on the other side of this process may well be drastically different from the current complicated process that banks must undertake to attempt to comply.

Some of those who were there at the birth of the proprietary trading ban lament the laboured political calculation that went into its creation. The dysfunctional past of the Volcker rule is casting a cloud over its future.

“Just like in the case of the Lincoln amendment, the stuff that was inserted at the end of the legislative process for Dodd-Frank was the worst. It was not thought out, it was not vetted and these things arose purely due to politics,” concludes Lamson.

  • LinkedIn  
  • Save this article
  • Print this page  

Only users who have a paid subscription or are part of a corporate subscription are able to print or copy content.

To access these options, along with all other subscription benefits, please contact [email protected] or view our subscription options here:

You are currently unable to copy this content. Please contact [email protected] to find out more.

You need to sign in to use this feature. If you don’t have a account, please register for a trial.

Sign in
You are currently on corporate access.

To use this feature you will need an individual account. If you have one already please sign in.

Sign in.

Alternatively you can request an individual account here: