And so it is done (as we detailed here)… and due to be put in place as of April1st 2014 (rather ironically). The 100-plus-pages of rules and regulations prohibit two activities of banking entities: (i) engaging in proprietary trading; and (ii) owning, sponsoring, or having certain relationships with a hedge fund or private equity fund. But the kicker…
requires banking entities to establish an internal compliance program designed to help ensure and monitor compliance with the prohibitions and restrictions of the statute and the final rule.
Great! Because self-regulation worked so well in the past for the financial services industry.
Who will be most affected?
Merriam-Webster’s Dictionary defines “speculation” in 31 words. The key ones are “risk of a large loss.” When Paul Volcker, the former U.S. Federal Reserve chairman, proposed banning speculation by federally insured banks to reduce risk to the world economy, he did it in one paragraph. Four years later, the nation’s regulators are poised to vote on Volcker’s proposal. The rule now runs close to 100 pages, with hundreds more in supporting material — and no one is quite sure how it would be enforced. It’s a lesson in how complicated simplifying Wall Street can be.
The idea became law in the Dodd-Frank reforms of 2010, but turning it into regulations has been slowed by a lobbying onslaught. Already many banks have shut down or spun off the desks they used for trading that was clearly solely for their own account, what’s known as proprietary trading. Banks do other kinds of trading that can also make them money, or loses it: Some of the trades are to help clients, and others are to reduce the risks of their own lending or trading. Figuring out which trades fall into which category isn’t always easy, and deciding how much risk is too much for which kind of transaction may be even harder. On these issues, how regulators decide to enforce the rules may be as important as the rules themselves, particularly as responsibility will be split between five agencies set to announce the final rule on Tuesday. They have very different agendas: Some are primarily concerned with keeping markets working smoothly, while others worry mostly about keeping banks from blowing themselves up.
After the Great Depression, Congress created federal deposit insurance to prevent runs at commercial banks. In return, the banks had to concentrate on making loans and leave the fancy stuff to investment banks. That dividing line blurred in the ’90s and was erased entirely in 1999 when the Glass-Steagall Act was repealed at the behest of banks like Citigroup that promptly grew big trading operations. The financial crisis of 2008 had its seeds in bad mortgages, but what brought banks to the brink, Volcker noted when he proposed his idea, wasn’t bad loans but the exotic trades they had made around them. The six largest U.S. banks made $15.6 billion in trading profits during 13 of the 18 quarters that spanned mid-2006 to 2010. They racked up bigger losses during the five remaining quarters when their bets turned sour. Even after the meltdown and unpopular taxpayer bailouts, taking a step back toward Glass-Steagall met Wall Street resistance. That’s why when President Barack Obama adopted the idea he wrapped it in Volcker’s name, in the hope that the towering stature of the man who tamed 1970s inflation would lend it greater weight.
Banks continue to insist that it’s impossible to distinguish between prop trades and what banks call market making — the steady stream of buying, selling and holding they do so their customers can always buy what they want to buy and sell what they want to sell. Jamie Dimon, the chief executive officer of JPMorgan Chase, said that every trader would need a psychologist and a lawyer by his side to make sure he wasn’t breaking the rule. Some regulators have grown wary of trades banks say they’re making to offset specific risks since JPMorgan Chase’s $6 billion London Whale losses, which Senate investigators saw as closer to gambling than to hedging the bank’s other bets. Volcker has said the rule could accommodate both kinds of trades and still stay fairly simple. “It’s like pornography,” Volcker said of prop trades. “You know it when you see it.” Instead of blanket bans, however, regulators sought to define each situation and carve out a string of exemptions, which is how the rule grew and grew. A small but growing number of bipartisan voices in Washington say they may push for a more radical simplification — bringing back Glass-Steagall.
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