Near the end of 2007, the United States was hit by the subprime mortgage market meltdown. For years before, the public had experienced a steady increase in home prices and a seemingly never-ending supply of mortgage lending. Homeowners were able to enjoy ever-increasing home equity and mortgage products, virtually guaranteeing that anyone who wanted to get financed could. Homeowners took advantage of this, sometimes financing and re-financing homes multiple times and using the newfound equity to consolidate other debt or to spend elsewhere.

What we now know is that the rise in home prices soon would end, and the mortgage market that looked robust on its face was built on adjustable-rate loans, interest-only loans, loans given without verifying employment, mortgage-backed securities, and collateralized debt obligations. When home prices began to level off, consumers saw the gains in their equity slow. Without a way to refinance again, consumers were over-extended, and they began to default on their mortgage loans.

That is not to say consumers alone caused the meltdown. There has been no shortage of regulators and commentators who have criticized banks for what they saw as risky investments in subprime mortgages and questionable lending tactics. Ultimately, the subprime mortgage meltdown would spread to other financial sectors and lead to what widely has been regarded as the worst financial crisis since the Great Depression of the 1930s.
     
Lawyers often use the phrase “bad facts make bad law,” meaning that an egregious situation may lead to a result that, while it resolves the situation at hand, will cause problems later.     Many have claimed that the government’s reaction to the global financial crisis did just that.

On July 21, 2010, President Barack Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act. Referred to generally as Dodd-Frank, its purpose was to implement the most sweeping changes to the United States financial system since the laws enacted after the Great Depression. Composed of 16 separate titles, with each addressing different segments of the financial industry, the act made significant changes to several federal financial statutes and regulatory agencies.

One of the provisions included in Dodd-Frank is the Volcker Rule. Named after former Federal Reserve Chairman Paul Volcker, the rule attempts to prohibit what it sees as risky investments by certain entities, including banks. It does this by prohibiting what it terms a “banking entity” from engaging in two activities. Generally speaking, any bank or savings association whose deposits are insured by the Federal Deposit Insurance Corporation (the FDIC) falls within the definition of a banking entity. Under the rule, banking entities are prohibited from “engag[ing] in proprietary trading” in securities, derivatives, options, and other investments. The rule also prohibits banking entities from “acquir[ing] or retain[ing] any equity, partnership, or other ownership interest in or sponsor[ing] a hedge fund or a private equity fund” with some limited exceptions.

The rule also contains several other requirements, such as the requirement that the Financial Stability Oversight Council (“FSOC”) study and recommend changes in the law to promote the safety and soundness of banks, limit risks to taxpayers and consumers that “depository institutions will engage in unsafe and unsound activities,” and reduce the possibilities of conflicts of interest between banking entities and their customers. The rule then directs federal banking regulators, the Securities and Exchange Commission, and the Commodity Futures Trading Commission to consider FSOC’s recommendations and adopt rules to effectuate them.

Despite all of these other provisions, the primary restrictions in the rule have been summed up as prohibiting so-called proprietary trading and acquiring an interest in a hedge fund or private equity fund. It is this behavior that the rule aims at stopping. Proponents of the rule, including its namesake, argue that such behavior is inherently risky and was a central factor in leading to the financial crisis. They argue that banks should not be engaging in these risky bets while the FDIC is guaranteeing their deposits.

Critics of the rule charge that proprietary trading by banks had little to no role in causing the financial crisis. They also complain the definition of “proprietary trading” is too sweeping and catches legitimate market-making activity. As a result, they claim the rule places banking entities at a competitive disadvantage when competing in the global marketplace. This disadvantage is heightened, they claim, as the rule forces top talent at banks to leave if they wish to continue proprietary trading and investing in hedge funds or private equity funds.

In January 2017, lobbyists for the financial industry announced a plan to focus on either changing the Volcker Rule or eliminating it. Olivia Oran, Wall Street reporter at Thomson Reuters, reported that shortly after the November 2016 election, lobbyists began meeting with legislative staff to discuss the issue. With the promise of a more business-friendly government, the financial industry is hoping that President Trump’s administration and a Republican-led Congress will provide the opportunity to alleviate some of their criticisms of the rule.

One lobbyist noted that a complete repeal of the rule would be unlikely and that the more probable result is a change in some of the rule’s requirements. One change they would like to make is to reverse the language in the rule that assumes all bank trades are proprietary unless a bank can prove otherwise. Another focus is to clarify the requirement in the rule that banks may hold only enough securities to satisfy what the rule calls the “reasonably expected near-term demand” from its customers.

In order to make these changes, lobbyists know they will need 60 votes in the Senate to stop any filibuster on a bill they propose and force a vote. With 52 Senate Republicans, lobbyists will need to convince at least eight Democratic senators that the rule needs changing. To do this, lobbyists have stated that they intend to focus on Democratic senators that they see as business-friendly. Chief among those identified is West Virginia’s Senator Joe Manchin. As the lone Democratic Senator from West Virginia, which overwhelmingly voted for the new President, there is a belief that Manchin will face serious Republican challengers in the next election and may be looking for ways to appeal to his conservative constituents that he is an ally in bipartisan reform.

Others in the party, such as Senator Elizabeth Warren, historically have been critical of any measure that could be seen as benefitting banks. It is unlikely they would support any measure to amend or repeal the Volcker Rule. What is not yet known, however, is what response they would make to any efforts by Senate Democrats to change the rule. Senator Manchin, along with a handful of other Democratic senators across the country, could soon become central figures in this fight.