Regulating Motivation: A New Perspective on the Volcker Rule

44 Pages Posted: 9 Aug 2017

See all articles by Ryan Bubb

Ryan Bubb

New York University School of Law; European Corporate Governance Institute (ECGI)

Marcel Kahan

New York University School of Law; European Corporate Governance Institute

Date Written: August 3, 2017

Abstract

The myriad problems with the Dodd-Frank Act’s ban on proprietary trading by banks have led to a rare bipartisan consensus: the Volcker Rule must be pared back or even repealed. At the root of the Rule’s problems is the fundamental definitional challenge posed by the current approach. The definition of banned proprietary trading turns on the motivation underlying a trade, which is difficult for regulators to determine. Regulators must adopt either a hardline approach that risks deterring banks from engaging in core financial intermediation functions or a more permissive approach that risks the continuance of speculative gambles that threaten the financial system.

We propose a new paradigm for achieving the Volcker Rule’s objectives that resolves this dilemma. Rather than define and ban proprietary trading, regulators should simply ban banks from paying traders on the basis of trading profits. Our proposal takes advantage of the competition between proprietary trading firms in two markets: they compete in the securities market to identify and exploit trading opportunities and they compete in the labor market to hire and motivate the best traders. Because speculative trading is a zero-sum game, handicapping banks relative to unregulated entities, such as hedge funds, in the labor market for traders would generate powerful incentives for banks to get out of the trading game. Our simple compensation-based approach would likely be more effective at ending speculative trading at banks---and do so at lower cost---than the complex and loophole-ridden current approach.

Suggested Citation

Bubb, Ryan and Kahan, Marcel, Regulating Motivation: A New Perspective on the Volcker Rule (August 3, 2017). NYU Law and Economics Research Paper, Working Paper No. 17-27 , Available at SSRN: https://ssrn.com/abstract=3016034 or http://dx.doi.org/10.2139/ssrn.3016034

Ryan Bubb (Contact Author)

New York University School of Law ( email )

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New York, NY 10012-1099
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(212)992-8871 (Phone)

HOME PAGE: http://https://its.law.nyu.edu/facultyprofiles/profile.cfm?personID=34148

European Corporate Governance Institute (ECGI) ( email )

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

Marcel Kahan

New York University School of Law ( email )

40 Washington Square South
New York, NY 10012-1099
United States
212-998-6268 (Phone)
212-995-4341 (Fax)

European Corporate Governance Institute ( email )

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

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