Statement of Commissioner Allison Herren Lee on the Final Rules Continuing the Repeal of Volcker
June 25, 2020
A lot has happened since these final rules were proposed in late January of this year.[1] America is in the midst of an economic crisis the scope and severity of which are “without modern precedent.”[2] Large financial institutions have seen profits plummet from 40% to 89% compared to the same period last year as they brace for enormous losses in their loan portfolios.[3] The impact on private funds—such as the venture capital and credit funds that today’s rule opens to the nation’s banks—is as yet unclear.[4]
The final rules, however, unaccountably fail to consider this historic turn of events.[5] These rules will continue to loosen safeguards put in place after the last financial crisis to protect taxpayers from risky bets made by banks.[6] We do this precisely as the global economy enters an even greater, more foreboding crisis of as yet unknown length and severity. I cannot support the decision to proceed in the face of tremendous uncertainty regarding the evolving effects of the current crisis, and without even attempting to analyze or quantify its current impact.[7]
At the proposal stage, I identified many of my substantive concerns with the policy choices made.[8] In short, the changes will facilitate the accumulation of risky, illiquid investments on bank balance sheets by permitting investment activity that is contrary to Congress’ expressed intent in adopting the Volcker Rule.[9] The agencies achieve this result through an interpretive re-imagination of Volcker that, in certain respects, strains credulity.[10] My concerns regarding these issues are now sharply heightened by the potential for continued economic decline—marked by rising business failures and widespread borrower defaults—to exact an even greater toll on banks’ financial condition.[11]
Today’s adopting release mentions the effects of the COVID-19 crisis only in the context of the determination not to extend the comment period.[12] The release states that “[t]he agencies … do not believe that further delay of the rule is warranted, given the volume, depth, and diversity of comments submitted.” Regardless of how robust the comments may be to date, none provide (nor could they) a careful analysis of the impacts of the crisis on the policy choices reflected in the final rule—something that will only become clearer in the months ahead.
Without the benefit of any analysis whatsoever as to how the present financial crisis bears on the policies reflected in today’s rules, the conclusions as to whether today’s changes are advisable are unsupported and premature.[13] For this reason, as well as the concerns I expressed at the proposal stage, I respectfully dissent.
[1] The proposal was published in the Federal Register on February 28, 2020, just before the economy began a substantial downward trajectory. See Proposed Rule, Prohibitions and Restrictions on Proprietary Trading and Certain Interests in, and Relationships With, Hedge Funds and Private Equity Funds, Bank Holding Co. Act Rel. No. 8 (Jan. 30, 2020) (“Covered Funds Proposing Release”). The pressure on banks to date has been immense, and many saw sizeable balance sheet increases in Q1 2020 due to credit line drawdowns by existing clients. See, e.g., Eric Platt et al., Financial Times, Dash for Cash: Companies Draw $124bn from Credit Lines (Mar. 25, 2020). That pressure is likely to increase in the months ahead as the effects on the real economy of COVID-19 drag on. For example, starting in March 2020, unemployment claims spiked to historic levels, hitting an all-time high of nearly 7 million initial claims in a single week. See Department of Labor, News Release: Unemployment Insurance Weekly Claims (June 18, 2020). The most recently available data—for the week ending June 13—shows that approximately 20.5 million individuals filed continuing unemployment claims, with initial claims totaling approximately 1.5 million. See id. At the same time, home mortgage data shows that the number of delinquencies rose in May to the highest level in 9 years—a 20% increase from April 2020 and a 131% increase from May 2019. See Black Knight’s First Look at May 2020 Mortgage Data, Black Knight Inc. (June 22, 2020). Lastly, some experts predict that the accelerating pace of corporate bankruptcies could set a record for companies with debt exceeding $1 billion. See Mary Williams Walsh, NY Times, A Tidal Wave of Bankruptcies is Coming (June 18, 2020). See also Federal Reserve Bank of St. Louis, COVID-19 Financial Data Tracking, https://research.stlouisfed.org/dashboard/49752 (providing a dashboard for monitoring the financial conditions in the U.S. economy, with a focus on market stress from the COVID-19 pandemic).
[2] See Remarks of Jerome H. Powell, Chair, Board of Governors of the Federal Reserve System (May 21, 2020) (“We are in the midst of an economic downturn without modern precedent. It was sudden, and it is severe. It has already erased the job gains of the past decade and has inflicted acute pain across the country.”).
[3] See Rachel Siegel & Thomas Heath, Washington Post, U.S. Stocks Plunge Amid Steep Falls in Oil Prices, Bank Earnings and Retail Sales (Apr. 15, 2020) (“On Wednesday, Bank of America, Goldman Sachs and Citigroup all announces first-quarter profits fell at least 40 percent compared with the same period last year. On Tuesday, JPMorgan Chase and Wells Fargo announced quarterly drops of 69 percent and 89 percent, respectively.”). See also Laura Noonan, Financial Times, U.S. Banks Brace for Surge in Loan Losses (Apr. 18, 2020) (“Big U.S. banks made one thing clear this week: they are battening down the hatches to deal with an expected surge in loan losses as the pandemic casts serious doubts over the capacity of consumers and companies to pay their debt. Loan loss charges at six big American banks reached a total of $25.4bn in the first quarter. This marks a 350 per cent surge in collective provisions across Bank of America, Citigroup, JPMorgan Chase, Wells Fargo, Goldman Sachs and Morgan Stanley versus a year earlier, as charges soared to levels not seen since the financial crisis.”).
[4] See James Thorne Priyamvada Mathur, PitchBook, Facing Crisis, Venture Capitalists Follow a New Script (June 2, 2020) (“Post-pandemic, the new playbook for venture capital investing calls for a slower and more defensive approach—a short about-face to years of frenzied deal-making, often at lofty valuations. It will also redraw the lines around areas of opportunity, picking winners and losers for a world that has changed dramatically in the short term, and in some ways permanently. ‘Coronavirus is going to break the time-series data. It’s going to throw off all the charts,’ said Rob Stavis, a partner at Bessemer Venture Partners. ‘I think the only time I remember that happening was in 1987, after the stock crash.’”).
[5] See generally Final Rule, Prohibitions and Restrictions on Proprietary Trading and Certain Interests in, and Relationships With, Hedge Funds and Private Equity Funds, Bank Holding Co. Act Rel. No. 9 (June 25, 2020) (“Covered Funds Adopting Release”).
[6] Today’s rulemaking marks the second time in the past year that the agencies have chosen to roll back the protective measures in the Volcker Rule. See Final Rule, Revisions to Prohibitions and Restrictions on Proprietary Trading and Certain Interests in, and Relationships With, Hedge Funds and Private Equity Funds, Bank Holding Co. Act Rel. 7 (Sept. 18, 2019).
[7] See Remarks of Jerome H. Powell, Chair, Board of Governors of the Federal Reserve System (May 21, 2020) (“While the economic response has been both timely and appropriately large, it may not be the final chapter, given that the path ahead is both highly uncertain and subject to significant downside risks. Economic forecasts are uncertain in the best of times, and today the virus raises a new set of questions: How quickly and sustainably will it be brought under control? Can new outbreaks be avoided as social-distancing measures lapse? How long will it take for confidence to return and normal spending to resume . . . The answers to these questions will go a long way toward setting the timing and pace of the economic recovery. Since the answers are currently unknowable, policies will need to be ready to address a range of possible outcomes.”). As I have stated, the evolving nature of the crisis’ impact supports a cautious approach to regulatory priorities. See Commissioner Allison Herren Lee, Regulatory Priorities and COVID-19 (Apr. 3, 2020). This rule-making provides the quintessential example of the type of action that is ill-advised at present because of the inability to gage the economic the economic effect of our action in light of rapidly evolving economic conditions. Moreover, the final rules do not even attempt to analyze currently known data regarding the effects of this financial crisis.
[8] See Statement of Commissioner Allison Herren Lee on the Continued Repeal of the Volcker Rule (Jan. 30, 2020).
[9] See id.
[10] At proposal, the agencies asserted that permitting banks to invest in venture capital funds “could promote the safety and soundness of banking entities and the financial stability of the United States.” See Covered Funds Proposing Release, supra note 1, at 69. That assertion—which is required by Section 13 of the Bank Holding Company Act in order to expand permitted activities under the rule—is absent from today’s adopting release. See 12 U.S.C. 1851(d)(1)(J) (authorizing the agencies to permit “such other activity as the [agencies] determine, by rule, would promote and protect the safety and soundness of the banking entity and the financial stability of the United States.”). It is not enough to claim that such activities will not cause harm; Congress required that the agencies determine that any additional permitted activities promote and protect safety and soundness and financial stability. While the release describes the ways in which the relevant conditions in today’s final rules might limit the risk to banking institutions of investments in venture capital, that does not meet the high bar that Congress established in Section 13. See Covered Funds Adopting Release, supra note 5, at 190 (“[N]othing in the final rule removes or modifies prudential capital, margin, and liquidity requirements that are applicable to banking entities and that facilitate the safety and soundness of banking entities and the financial stability of the United States.”). Likewise, the adopting release’s claim that investments in venture capital funds and credit funds are similar to investment activities in which banks can otherwise engage ignores the important distinctions between direct investment and loans (in which the bank benefits from a greater degree of transparency and control of its credit and other exposure) and private fund investments by the bank (through a typically illiquid and opaque fund vehicle that does not offer those same benefits).
In addition, the adopting release erroneously claims the authority to permit banking entities to engage in specified “covered transactions” with covered funds. The statutory Volcker Rule contains an unambiguous prohibition of all “covered transactions,” as that term is defined in the relevant banking laws. See 12 U.S.C. 1851(f)(1). The proposal and today’s adopting release rely heavily on the fact that the original implementing regulations permitted banks to maintain a de minimis investment in covered funds, notwithstanding the fact that such investments would constitute a “covered transaction” that would appear to be subject to the general prohibition. See Covered Funds Adopting Release, supra note 5, at 132-134; Covered Funds Proposing Release, supra note 1, at 90-94. The agencies essentially claim that, if they have the authority to permit de minimis investments, they must also have general authority to permit other covered transactions. Id. Importantly, however, the statute itself provides the exception for banking entities’ de minimis investments in covered funds. See 12 U.S.C. 1851(d)(4). Congress established a general prohibition and then crafted a specific exception, and the agencies merely implemented the legislative text. The statute contains no analogous exception for the classes of covered transactions carved out by today’s rulemaking. If we are to take anything from Congress’ determination to provide a specific exception to the prohibition on covered transactions, basic principles of statutory construction would lead to the opposite result. See Antonin Scalia & Bryan A. Garner, Reading Law at 107 (2012) (discussing the negative-implication canon of statutory construction, which generally provides that the expression of one thing implies the exclusion of others).
[11] See Frank Partnoy, The Worst Worst Case, The Atlantic (July/August 2020) (discussing banks’ vast exposure to collateralized loan obligations (CLOs) backed by loans to troubled businesses and the potential for a prolonged economic decline and to inflict sizeable losses on banks). See also Morgan Stanley, First Quarter 2020 Earnings Results (Apr. 16, 2020) (“We experienced significant decreases in the valuation of loans and commitments, investments and certain classes of trading assets, an increase in the allowance for credit losses, and reduced net interest income and investment banking fees. The credit deterioration within Institutional Securities was notable, with mark-to-market losses, net of economic hedges of $610 million on loans held for sale and a provision of $388 million for credit losses on loans and unfunded lending commitments held for investment.”); JPMorgan Chase & Co., First-Quarter 2020 Results (Apr. 14, 2020) (“The provision for credit losses was $8.3 billion, up $6.8 billion from the prior year driven by reserve builds which reflect deterioration in the macro-economic environment as a result of the impact of COVID-19 and continued pressure on oil prices.’); Wells Fargo, 1Q20 Quarterly Supplement (Apr. 14, 2020) (“$3.1 billion reserve build reflects forecasted credit deterioration due to the COVID-19 pandemic, credit weakness in oil and gas, and stronger than expected loan growth including draws on loan commitments, and includes a $2.9 billion reserve build for loans and a $141 million reserve build for debt securities”).
[12] See Covered Funds Adopting Release, supra note 5, at 14.
[13] Congress also expressly limited the agencies’ authority to expand permitted activities under the Volcker Rule by prohibiting any activity that would, among other things, result in material exposure by the banking entity to high-risk assets or pose a threat to the safety and soundness of the banking entity. See 12 U.S.C. 1851(d)(2). In light of the decision to move forward at a time of such uncertainty while the effects of the current crisis on venture capital and credit funds remain unclear, it cannot reasonably be shown that the changes we adopt today comport with the limits established by Congress.