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Tell me again: What's the Volcker Rule?

Former Federal Reserve Board Chairman Paul Volcker testifies during a hearing.

Next week U.S. regulators will vote on the Volcker Rule, a key part of the Dodd-Frank financial reform legislation that was created to prevent another financial meltdown. The Volcker Rule is intended to stop big banks from making speculative bets with depositors' money, money that is backed by the FDIC, so that if those bets go bad, taxpayers won't be on the hook for losses. The question is, will the rule have the teeth to do that?

When the Volcker Rule was first introduced, the big banks immediately begin attacking it.

"And for a considerable time period, all the rumors were that they were having great success, they were getting a very weak version of the Volcker Rule," says Bill Black, former bank regulator and deputy director of the Federal Savings and Loan Insurance Corporation (FSLIC).

But then along came a disaster, the London Whale bet, which resulted in over $2 billion in losses at JPMorgan. The loss from that bet, Black says, "was greater than all of their supposed gains. In other words, everything Paul Volcker warned about turned out to be true."

Regulators responded by creating a tougher version of the Volcker Rule, with fewer loopholes that would allow banks to make trades for themselves. But banks could continue making those trades, called proprietary trades, if they were called hedges.

"When you are dealing complex financial products and these very arcane rules, it's easy to spin a hedge or a trade in one way or another to suit your own purposes," says Anisha Sekar, a financial advisor with Nerd Wallet.

So the Volcker rulemakers set out to define every type of trade in order to prevent these sorts of evasions from the law, which would make it even tougher.

"Here's the Dark Side of all this," says Black. "If you try to cover in your rule every means of potential evasion of something you are calling a hedge that isn't really a hedge, you end up with what the rumors say is about to come out, which is a well over 800 page rule."

Regulators will make their final decision on The Rule on Dec. 10.

About the author

David Weinberg is a general assignment reporter at Marketplace.
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