Last month, after some last-minute compromises, federal regulators approved the final version of the Volcker Rule. This is a centerpiece of the Dodd-Frank Act, which seeks to rein in risk-taking on the part of financial institutions five years after the financial crisis and too-big-to-fail bank bailouts. The rule was drafted in 2011 by then-Federal Reserve Chairman Paul Volcker. Its mission is to reduce the chance that banks will put federally insured depositors’ money at risk by banning banks from trading for their own gain, known as proprietary trading.
Passage of the Rule was supported by Treasury Secretary Jacob J. Lew, who told regulators the deal was too important to delay and called for its passage by the end of 2013. President Obama also urged for passing of the rule. Both met with 86-year-old Volcker several times prior to the measure passing. This vote underlines the strength of Dodd-Frank and is part of the most sweeping overhaul of bank regulation since the Great Depression.
In fact, the Volcker Rule and the Dodd-Frank Act are attempts to compromise from reinstating the Glass-Stegall Act, otherwise known as the 1933 Banking Act, which was established to restore consumer confidence in banks after the Great Depression. Glass-Stegall prevented commercial banks from owning affiliates that underwrite and trade securities.
In 1999, Congress passed the Gramm-Leach-Bailey Act, which repealed part of Glass-Stegall, deregulating banks and removing the firewall between commercial and investment banking. This deregulation is viewed as the cause of the 2008 financial crisis, a position that was ultimately supported by both Democrats and Republicans.
However, those in opposition to the Volcker Rule worried it would hamper banks’ flexibility, holding up trades that might be critical to their financial health and to the health of the economy. They argued that the recent financial crisis was due to banks’ risky mortgage lending more so than trading. In fact, support of the Volcker Rule ultimately split along partisan lines, with Republicans largely expressing concern the rule could possibly hamper economic growth.
But the Volcker Rule found support in 2012 from an unlikely source: JPMorgan. When the financial giant admitted that faulty derivative investments eventually cost its clients more than $6.2 billion in losses, it underscored the dire need for regulatory oversight. The final version of the Volcker Rule requires banks to prove to regulators annually that they have a process in place to “establish, maintain, enforce, review, test and modify” programs that will monitor their compliance with the rule. However, it does grant some concessions to Wall Street. Among these is a delay in the implementation of the rule to July 2015. It is expected that banks will use the time in the interim to look for loopholes.
Sources: New York Times and Insurance Journal
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