On Tuesday, December 10, 2013, the Federal Deposit Insurance Corporation (FDIC) along with 4 other agencies passed the Volcker Rule, while a 5th agency has stated it will also pass the rule, but behind closed doors. The Volcker Rule is a huge win for President Obama in regards to financial reform, fundamentally changing the way banks on Wall Street operate and severely limit the relationship between commercial and investment banks.
More specifically, the new law separates investment banking, private equity and proprietary trading (hedge fund) sections of financial institutions from their consumer lending arms.
Glass-Steagall was passed after the Great Depression, as part of the U.S. Banking Act of 1933. The aim of the bill was to prevent banks from using customer’s money to make hedges on possible future banking losses. It was around this time that the FDIC was also created to ensure that any money placed in a bank up to a certain limit would always be there.
During the Great Depression, and prior to the FDIC, there was a rush on the banks of customers pulling their money in fear that the bank would not be there tomorrow. This caused the Depression to become even worse than it may have been, and it is why many of our parents and grandparents still keep money “under their bed” and away from banks. The inherent distrust that was created was so severe that no amount of regulations could change that.
Despite that, Glass-Steagall eventually did its job. It instilled enough confidence that money being placed in the bank would be used for reinvestments in the community in the forms of loans and, when it was needed, it would be there.
Unfortunately, over the years, the divide between commercial and investment banks was dissolved. During the Reagan Administration, many of the provisions of Glass-Steagall were weakened or repealed. By the time President Clinton was in office, Glass-Steagall was only a ghost of what it once was. In 1999, Senator Phil Gramm (R-TX), Senator Jim Leach (R-IA) and Representative Thomas Bliley, Jr. (R-VA) successfully put a bill together that put the death knell in the law and lobbied a repeal effort.
Since that time, it has been an uphill fight to replace Glass-Steagall with something that had the footing the law once had. With Wall Street and corporate interests more influential than ever, doing so was no easy task. The turning point came at the end of the Bush Presidency and the beginning of the Obama Presidency.
After the financial crisis in America, President Obama was looking to put in place rules and regulations that would prevent the banks from destroying our economy again. Despite all odds, in 2010, President Obama successfully passed through Congress the Dodd-Frank reforms. One provision of the law was called the Volcker Rule. On Tuesday, the Volcker Rule was successfully approved.
U.S. banks will no longer be able to make big trading bets with their own money after regulators on Tuesday finalized the Volcker rule and shut down what was a hugely profitable business for Wall Street before the credit crisis.
After struggling for more than two years to craft the complex rule, five regulatory agencies signed off on the nearly 900-page reform that included new tough sections narrowing carve-outs for legitimate trades.
The rule is expected to eat into revenues at large investment banks such as Goldman Sachs and Morgan Stanley, even if many have already wound down some of their trading desks in anticipation of the rule’s release, and may spark legal challenges.
The Volcker Rule is looking to reform a very complex system, and thus is not a black and white rule change. A very well written summary of the Rule can be found here. In short, what the Volcker Rule does is set limits between commercial and investment banks, much like happened after the passage of Glass-Steagall. It also severely limits the amount of hedging allowed by a bank to offset their own financial shortcomings.
Paul Volcker, who was the Federal Reserve Chairman under President Carter and Reagan, was named Chairman of the Economic Recovery Advisory Board by President Obama from February 2009 to January 2011.
Needless to say, Mr. Volcker’s Rule is not very popular with Wall Street. It is expected the implementation will be delayed through law suits, however, it will only be delaying the inevitable. Much needed reform is coming to Wall Street that is aimed at protecting the consumers. Republicans and banks a like will try to tell us how bad it is for the public, but one need look no further than the 2012 J.P. Morgan’s “London Whale” scandal, which could have been prevented had the Volcker Rule been in place.
The Volcker Rule is a 21st century Glass-Steagall. No single piece of legislation or rule change will bring back what once was. With Wall Street and corporate interests controlling Washington today, that is simply an impossibility. However, the Volcker Rule will go a long way towards helping President Obama bring back the protections that consumers need.
AP discusses the Volcker Rule and the effect it will have on the banking industry.