After several fits and starts, the Volcker Rule is finally reality, even if doesn't take effect until July 2015. The big question is whether this regulation will have the teeth to effectively curb the risky proprietary trading of the Too Big to Fail Banks.
the volcker rule
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The Too Big to Fail Banks thought they had Congress completely flummoxed by the complexity of their trading strategies. Any rules that emerged from the Dodd-Frank law would be full of loopholes, or utterly toothless. But then one member of the club did something incredibly stupid. Now, for the first time in years, Washington is
The Volker Rule is one of the elements required by the Dodd-Frank financial oversight law, which was written to rein in the sort of excessive Wall Street risk-taking that led to the financial crisis of 2008.
A draft version of the rule was released this week by the U.S. Federal Reserve, which was approved by both the Federal Deposit Insurance Corporation (FDIC) on Tuesday and the Securities and Exchange Commission (SEC) yesterday (Wednesday).
The rule aims to ban proprietary trading, in which the banks traded for their own benefit rather than for the benefit of their customers, but also will address other areas such as hedge fund investing.
Since a significant chunk of the big banks' profits - especially that of Goldman Sachs Group Inc. (NYSE: GS) and Morgan Stanley (NYSE: MS) - come from various forms of proprietary trading, the Volcker Rule stands to cost the industry billions in revenue.
To prevent cheating, complex compliance rules will require that banks prove that all their trading activities are for clients' benefit, and not proprietary. Compliance alone is expected to tack on another $2 billion in costs.
"[The Volcker Rule will] diminish the flexibility and profitability of banks' valuable market-making operations and place them at a competitive disadvantage to firms not constrained by the rule," noted a report by Moody's Corp. (NYSE: MCO).
The rule is named for former Fed Chairman Paul Volcker, who has made the case that such regulations are needed.
The new regulations will deal another blow to an already-struggling industry, which has watched earnings sag as a result of a falloff in equity trading volume, weak demand for loans, and costly legal headaches.
Although there's still time for the Volcker Rule to be tweaked before it takes effect on July 21, 2012, it will fundamentally change how the big banks operate.
The rule's impact on Goldman Sachs and Morgan Stanley will be particularly brutal, especially if the final version imposes broader restrictions.