Paul Volcker: Banks' Long-Term Investments Should Be Regulated

As legislators grapple with how to keep banks from engaging in risky, speculative behaviors, former Federal Reserve chairman Paul Volcker's views are clear: crack down on long-term investments.

The eponymous "Volcker Rule" proposes to prohibit banks from engaging in proprietary trading that is not on their clients' behalf, as well as limiting banks' investments in hedge funds and private equity. Supporters of the rule believe that such behavior helped contribute to the recent financial meltdown and that such restrictions will prevent a similar crisis.

Though specific legislation for the Volcker Rule is meant to be set by mid-September, ambiguity remains about how exactly the rule will be executed. A 79-page study released Tuesday by the Financial Stability Oversight Council, created as part of the Dodd-Frank Act, analyzed the ways in which the Volcker Rule might be applied.

Volcker himself told the Financial Times that the Council had made "a good honest effort" in adapting his rule, though his praise was intermingled with a certain amount of skepticism. In particular, he felt that regulators had perhaps "lost sight" of longer-term activities classified as merchant banking rather than proprietary trade.

"Potentially what is 'merchant banking' and what is a 'proprietary trade' needs some delineation, I think," he said.

One particularly tricky issue the council faces is how to analyze differences between long-term investments and short-term trades-- the Volcker Rule targets short-term trades. But according to Volcker, banks may engage in risky activities under the umbrella of allowable merchant banking that are just as potentially dangerous as short-term investments.

"I think the merchant banking provision should have been changed but that needs a little further work," he said in Financial Times. " I think the banking supervisors have an interest in that even without this proprietary trading rule and I think the merchant banking thing has to be looked at on its own grounds."

Goldman Sachs' $500 million Facebook gambit might be affected by such scrutiny regarding longer-term investments. Media attention has already led the bank to withdraw the investment opportunity from U.S. clients.