The Volcker Rule and the Trouble With Rules

Allan Sloan says the JP Morgan “fail whale” incident shows that the Volcker Rule is futile not that it’s necessary: “Once bank lawyers finish finding loopholes in the detailed provisions, whatever they prove to be, the rule will probably have little meaningful impact.”

This gets to the heart of the difference between rules-based and principles-based regulation. You could have a version of the Volcker Rule that functions by empowering a set of bank regulators to implement the principle behind the rule. Sloan agrees that “the principle sounds wonderful and simple – don’t let banks use federally insured deposits for risky trades” so you could tell the regulators just that, with no further details or clarification. A college dorm that has a rule against loud noise or music after 10PM on weeknights isn’t going to follow that up with a detailed regulatory definitions of “loud”, “noise”, and “music” that you can then try to find loopholes in. The issue is that if the RA decides you’re being too noisy, he tells you to quiet down.

The problem with principles-based regulation in this context is that you might fear that banks will use their political influence to get regulators to engage in a lot of forebearance. The problem with rules-based regulation in this context is that it’s really hard to turn a principle into a rule.