An alternative proposal to the Volcker Rule from a pair of corporate law professors would hold bank executives personally responsible for losses. Would this work?

In a post on Dealbook Claire Hill and Richard Painter, professors of corporate law at the University of Minnesota, propose an interesting alternative to the Volcker Rule.

The Volcker Rule, a part of the Dodd-Frank Wall Street Reform Act that limits speculative proprietary trading by banks that does not benefit their clients, has swollen from ten to 298 pages. It is currently in the public comment phase before it goes into effect next year.

Paul Volcker


Volcker Rule Unpopular Among Banks

It is quite unpopular among banks and shareholders, because it will seriously cut into banks’ profits — proprietary trading can be quite lucrative. It can also be risky. For FDIC-insured institutions, taxpayers are the backstop for risky investments, and the Volcker Rule aims to curb the extent to which banks can put taxpayer dollars at risk.

The Volcker Rule is also unpopular for how confusing and bloated it has gotten, which is what brings us back to Profs. Hill and Painter’s proposal.

Most investment banks started as private partnerships, the professors point out. As such, when they posted losses, the partners themselves were responsible for them. Once investment banks went public, they were able to leverage investors’ money into profits, and sometimes losses. This changed things.

“When their bets failed,” write the professors, “they might lose their jobs, but they could take lucrative severance packages with them and walk away from a firm’s liabilities. Other people’s money was other people’s problem.”

Proposal Makes Executives Take on Risks

They acknowledge that investment banks are not going to return to being privately-held companies, but their proposal involves bringing that personal responsibility back to the executive level of bank management. They propose that, instead of the ban on prop trading in the Volcker Rule, regulators hold bank executives personally responsible for bank losses. They would “require the most highly paid executives…to personally guarantee the debts of their firms in return for their high salaries and bonuses.”

They argue that by “changing incentives rather than expanding regulation,” they could better protect taxpayers from risky speculative trading. Scores of lawyers will pore over the massive 298 page Volcker Rule for loopholes and they will find them. With an incentives-based solution, the professors argue, the government can ensure that executives don’t take on unnecessary risks.

Do you think this will be more effective than Volcker?

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