After two years of review and lengthy revisions, all five regulatory agencies unanimously passed the controversial Volcker Rule on Tuesday.
The 953-page new version of the Volcker Rule imposes a strict ban on proprietary trading (when banks use their own funds to make trades). In effect, it bans banks from trading for their own gain. Included in the revised version is new wording targeting the sort of risk taking that was responsible for last year's $6 billion trading loss at JPMorgan.
The rule generally prohibits federally insured banks from wagering on risky investments such as private equity and hedge funds. The rule also requires chief executives to confirm that they have established compliance programs that ensure adherence to Volcker Rule provisions.
In other words: It hits greedy bankers, finally.
"It's about time the regulators stopped licking the banks' boots," said Money Morning Capital Wave Strategist Shah Gilani. "I'm shocked the rule is as extensive as it is. There are going to be a lot of sleepless nights for bankers in the future."
Indeed, the vote is seen as a blow to big banks, which usually get their way against Washington and the little guy. America's largest banks have until July 21, 2015, to comply.
"Big banks lost," Mark Williams, a former Fed bank examiner who now teaches at Boston University, told the Los Angeles Times. "Wall Street aggressively fought the Volcker rule."
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Volcker Rule Loopholes
While the rule prohibits banks from buying and selling most investments for their own accounts, there are broad exemptions:
- Banks can own securities when it is essential to serve trading and investment banking clients.
- Banks can own U.S. government debt.
- Banks can own securities that hedge other positions that banks legally own.
Gilani, in a Volcker Rule preview last month, noted that banks get creative when finding ways to dodge new regulations. That means regulators will have to remain tough on Wall Street.
"The ultimate effectiveness of the rule will depend importantly on supervisors," U.S. Federal Reserve Chairman Ben Bernanke said in a statement before Tuesday's vote. He added that it will take work to pair theory with action when it comes to enforcing the rule in real market practices.
The rule could slash as much as $10 billion total in yearly pretax profits from the eight largest U.S. banks through lower revenue and higher compliance costs, according to Standard & Poor's estimates. Goldman Sachs Group Inc. (NYSE: GS) stands to lose the most. About 25% of Goldman's annual revenue is "at risk from Volcker," writes FBR Capital Markets.
The rule could also make it more difficult for Wall Street banks to compete with overseas markets unless similar rules are enacted globally.
That's why Wall Street's fight against the Volcker Rule isn't over…
"Of course they'll do what they can to challenge it legally and undermine it wherever they can," said Gilani. "It's far from perfect, but it is a major victory for the new Treasury Secretary Jacob Lew, who deserves a standing ovation from the general public for not dilly dallying – from his first day in office he made the Volcker Rule a priority and expanded its reach."
And that's not the only person responsible…
"We should also thank Jamie Dimon and the London Whale and their ill-timed blow up," said Gilani. "Without it – which they said was a hedge waking up the world to banks' lies and utter deceit – who knows, Dimon could have been the next Treasury Secretary and I'd be writing these comments from another banana republic, one that actually grows bananas…"
Stay tuned for Shah's full Volcker Rule analysis, coming tomorrow…
Don't miss more from Shah: How the Masters of the Financial Universe Use Derivatives for Fun and Profit
- USA Today:
Volcker Rule Reins in Banks' Riskiest Trading
- Los Angeles Times:
Regulators OK Volcker Rule, Curbing Big Banks' High Risk Trades
Wall Street Exhales as Volcker Rule Seen Sparing Market-Making