Tuesday is scheduled to be the day that everything changes. Not everything, really, but it’s the day that the “Volcker Rule” will finally go into effect. “Leave the capital markets to their own devices without any expectation of government protection and keep the existing safety net for the commercial banking system,” Volcker said in 2009. In practice, this means that commercial banking, with deposits backed by the FDIC, have to be separated from stock trading and similar activities.
It’s not the Glass-Steagall Act, which required completely separate kinds of banks operating as different companies to perform the different kinds of investing. But it’s not bad. And if it sounds simple in principle the regulation authorized by Dodd-Frank takes 800 pages. Four years from its proposal and 3 years from its passage, it’s ready to roll out. How will it go?
The rule itself is certain to be watered down a bit, given how difficult it will be to implement. The details won’t be known until the final release, but there is an excellent breakdown available of what is to be expected by Wall Street after 3 years of testimony and over 20,000 written comments. It will certainly change how business is done.
The first problem faced by the new regulation will likely be lawsuits. There is a lot of money at stake here so we can’t expect the rollout to go smoothly. It will be worth it to hire a lot of very expensive attorneys, even if the end result is only delay.
What drove this simple proposal from sounding like a fantasy and/or a market breaker was the infamous “London Whale” loss of $6.2B by JPMorgan in a single series of trades. Everyone in the industry was spooked by the sudden realization that one action by one trader really could bring down the whole system and resistance melted among smaller banks. Not so the largest ones whose big advantages are about to be removed.
In short, it’s the end of socialized risk as we’ve known it. More or less, that is.
In the longer run the effect on the economy can only be positive. An awful lot of money has gone into risk investments, partly because of the low interest rates provided by commercial banking. When the return on a financial investment is more or less unlimited (based on how much risk the bank is willing to take) the appeal of real world investment in companies that make things and employ people is pretty diminished.
As we’ve discussed before, companies are running at record profit margins. Where very high margins were only realized by financial companies before 2008, the gap has narrowed dramatically. The Volcker Rule could make the difference that levels the playing field between the financial world and the physical real world that creates jobs for many more people. Investments in companies that make things or provide services will seem more attractive in the world that this rule will describe.
It won’t be easy. But it’s sure worth it to see what happens.
That wasn’t the original intent of the rule, of course. This is all about protecting the taxpayers from being on the hook for risky behavior that they have no say in. With Federal guarantees have to come restrictions. It’s not as though banks are prohibited from engaging in high risk trading or even have to divest themselves from such operations – as they were before 1999. But the lines are drawn pretty clearly to protect the taxpayers and allow the market to work as it pleases, each in their own way.
What we do know is that in banking, everything is about to change. Barataria’s policy in this area is even shorter than the Volcker Rule – banking should be boring. Here’s to a very boring future where the antics of a JPMorgan trading office don’t matter to anyone other than those who own JPM stock, so they can take it out on management in their own style on their own time.