U.S. regulators have announced that, after years of wrangling, on December 10 they are finally set to finalize the details of the so-called Volcker Rule. In case you’re saying to yourself about now, "Oh yeah, I kinda remember hearing about the Volcker Rule… What exactly does it do again?"– below, we offer you a refresher on the rule and why it’s taken so long to implement:
From the 1930s to the 1990s, there were two distinct kinds of banks in the U.S., commercial banks and investment banks.Commercial banks gave out loans, and offered a safe place to deposit your money, which would be insured by the federal government to be there when you needed it.
Investment banks, on the other hand, could be “razzle-dazzle river boat gamblers with their money, because there was no back up or guarantee of their deposits,” says James Brock, an economist at Miami University.
With the repeal of the Glass-Steagall act in the 1990s, those two kinds of banks started to merge. Meaning, if the river boat gambling went sour “then the entire institution is jeopardized,” Brock says. “Now you’ve got a big bail-out problem to protect small depositors.” Brock says that’s what happened in the 2008 financial crisis.
In the wake of that crisis, Congress passed the Frank-Dodd Act, and its centerpiece was the Volcker Rule. The rule will put some limits back on federally insured banks and their ability to take risky financial bets meant to make profits.
But Karen Petrou of Federal Financial Analystics says that can be complicated in today’s banking world.
Take "hedging" as an example. A hedge is a financial bet a bank will take on the markets to offset the risks that come with, say, giving out a 30 year fixed rate mortgage. Of course, that hedge could also be used not just to hedge risk, but to try to make big profits for the bank. (The infamous “London Whale” debacle last year, where J.P. Morgan Chase lost $6 billion in trading, was initially described by CEO Jamie Dimon as a “hedge.”)
“How do you tell the difference between a hedge that’s truly a hedge, and something that a bank says is a hedge, but in which they’re actually speculating,” Petrou says.
It’s that sort of tricky question that has prompted thousands of comment letters to federal regulators, intense lobbying from Wall Street banks, and hours of internal government debate. And it’s all supposed to finally come to a close next week. The result will be a nearly thousand page rule, which Brock worries will create “about a thousand billion loopholes.”