A key piece of a financial regulation law Congress passed in 2010 was finalized last week and is ready for enforcement by federal regulators.
Named after former Federal Reserve chairman Paul Volcker, the “Volcker Rule” is designed to keep banks from owning or acting like hedge funds. It was this very behavior that played a key role in the 2008 financial crisis that plunged the country into the Great Recession.
By keeping commercial banks out of the risky business of hedge funds, private equity companies and investment banks, it should stabilize the banking system and reduce taxpayer risk of future costly bank bail outs.
Under the rule, commercial banks will be required to trade primarily on behalf of their clients. It should make the financial system safer for families who apply for home loans and small businesses seeking lenders.
The sheer size of the rule, 71 pages, plus 800 pages of explanatory text, paints the picture of a complicated rule with ample room for interpretation by federal regulators. It is incumbent upon the regulators to act with the interests of the banks’ clients at heart.
The sheer complexity of the rule is testimony to the fact that regulators had a hard time isolating the precise distinction between proprietary trading and market trading. And the banks argued during rule-making that a wholesale ban on proprietary trading would restrict their ability to make money on behalf of their clients.
That’s about when JPMorgan traders in London made big trades on derivatives with the bank’s money and ended up costing the bank $6 billion. The JPMorgan experience just stiffened resolve to write a more restrictive rule.
The rule doesn’t kick in for the big banks until mid-2015, and not until 2016 for banks at a lower tier. There will be gray areas that will test the mettle of regulators.
“Federal regulators have now written the tough rules,” Rep. Denny Heck, 10th District and a Democratic member of the House Financial Services Committee, said. “The next needed step is vigorously enforcing them.”