A small army of Federal Agencies — the Treasury, Fed, FDIC, and SEC – have set forth a proposed implementation of the Volcker rule contained in the Dodd-Frank legislation, here. In short, the Volcker rule is a rule to disallow proprietary trading by banks and non-bank financial companies. The proposed rule does this and also covers relationships with hedge funds or private equity funds. There are exceptions for running a hedge fund under certain conditions, for example hedging investments or making some international investments. But in general, the rule limits investments in hedge funds to be small relative to the hedge fund size and to be small relative to the bank’s size.
There are potential adverse effects of this rule when combined with the restrictions imposed by the qualified investors rules. This is all about efficiently getting investment funds to businesses from savers. It makes sense to provide insured, liquid ways to save and to monitor and restrict the activities of banks that are insured. But then can people save in illiquid, risky ways? And how do businesses with illiquid risky investments get funding. Seems like we are pushing funds into banks and then forcing to make direct loans rather than hire others to make investments for them that are not debt contracts. Is this the right channel and are these the right contracts for getting fund to businesses from savers? I tend to think we want more equity-type contracts and less debt type contracts.