Volcker Rule Made Simple: Banks Can't Gamble With Our Money (Probably)

The Volcker Rule Made Simple: It Means Banks Can't Gamble With Our Cash"Kiss the dice, baby. Gimme a little luck," the banker whispers as he puts his money -- your money -- on the table. When the numbers come up, the chips go into his pile. When they don't ... well, some gamblers are just too big to fail.

This week, the government took a big first step toward shutting down the Can't Lose Room in the Wall Street Casino. The Volcker Rule, a proposal to limit the kinds of risky investments that banks can make, went before four government agencies. On Tuesday, the FDIC unanimously approved the rule, the Federal Reserve backed it, and on Wednesday, the Securities and Exchange Commission followed suit. The final version of the rule is now up for public comment for 60 days.

It's too soon to know exactly how the rule will shake out and how consumers will ultimately be affected. The hope is that it will mean taxpayers won't be on the hook again to bailout banks who gamble with their retail customers' cash.

Gamblers in Pinstripe Suits

Using bank deposits to make risky investments, a process known as "proprietary trading," isn't new -- but for decades it was illegal. The Glass-Steagall Act, a law forcing banks to close their investment/brokerage wings, was passed in 1933, in the middle of the Great Depression. By driving a wedge between boring banking and dangerous, sexy investing, the law sought to stabilize the banking system, and reduce the rampant conflicts of interest that plagued it.

But after years of steadily chipping away at Glass-Steagall, a GOP-led Congress repealed the law in 1999. Banks once again began investing their customers' federally-insured deposits, and kept the winnings for themselves. One of the most disastrous bets was shaky mortgage-backed securities.

For the bankers, proprietary trading was a win-win situation: They were gambling with money that was insured by the FDIC, so if they lost too much, they could count on the government to make their depositors whole. And, since the banks themselves were necessary for American businesses, the government couldn't afford to let them fail. In other words, the roulette wheel was fully insured.

As the money train picked up steam, it also trickled down, in the form of ever-more-exotic subprime mortgages and ever-easier credit. This, in turn, pumped up the housing industry, which exploded with a steroidal burst of energy, pouring out houses for newly-approved homeowners eager to buy their little bit of the American dream. These new home buyers signed ever-shakier mortgages that got mixed into ever-riskier securities, that the banks then invested in. As the cycle gained steam, banks recorded record profits ... until the whole process came crashing down.

What Kind of Regulation?

There's not really any question that America's big banks need to be regulated. The question is whether or not Glass-Steagall needs to come back. Treasury Secretary Tim Geithner didn't think so: After the recession, he proposed a compromise that would allow banks to keep their investment wings, but would also regulate them far more closely.

On the other side, Paul Volcker, a former Federal Reserve chairman, and former chair of President Obama's Economic Recovery Advisory Board, offered a more sweeping proposal: Arguing that "banks are there to serve the public," he claimed that their investments "create conflicts of interest." To clear up the problem, he proposed that they be barred from proprietary trading. In other words, banks could buy stocks and securities for their customers, but could not do so for themselves.

Meanwhile, investment houses -- which, under the Volcker rule, would be separated from banks -- could borrow buy and sell securities, but couldn't use money that was insured by the FDIC. If their investments went south, such institutions might fail, but would not be able to drag the whole American economy down with them.

Threading the Needle

On paper, the Volcker Rule is very simple: Traditional banking sits on one side of the line, investment sits on the other. But in the current version that was approved by the FDIC, the line has been blurred by several exceptions -- and exceptions to the exceptions -- that make it hard to determine where commercial banking ends and proprietary trading begins. Americans for Financial Reform, a coalition group working to enact Wall Street reform, argue that the rule, as written, "leaves enormous scope for discretion by both banks and regulators." The rule's vagueness and exceptions, they warn, "raise serious doubts about whether this framework will actually produce the significant changes in bank practices that we need."

Economist Nouriel Roubini, who gained fame for predicting both the explosion of the housing bubble and the 2008 recession, was even more outspoken. Referring to the Volcker Rule as "Glass-Steagall Lite," the man called "Dr. Doom" argued that a much sharper line needs to be drawn between commercial banks and other financial services: "We need to go all the way and implement the kind of restrictions between commercial banking and investment banking that existed under Glass-Steagall."

It is not clear what effect the new rules will have on bank customers. Recently, The Wall Street Journal suggested that the Volcker rule could lead to higher fees for corporate customers, as banks would need to spend more money on self-regulation. Also, as Bank of America's (BAC) recent new debit card fee indicates, when banks are forced to close one revenue stream, they often try to create another. Still, given the high price of the 2008 bank bailout and the subsequent recession, a few new bank fees may end up being a bargain.

Bruce Watson is a senior features writer for DailyFinance. You can reach him by e-mail at bruce.watson@teamaol.com, or follow him on Twitter at @bruce1971.

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Although corruption and greed as well as insider trading will never completely go away, as it is a human shortcoming, we have to at least bring back the Glass Steagle Act if we want to reign in these Wall Street wise guys and "banksters" somewhat. The next step is to overhaul our ineffectual Gov't and bring back "common sense."...a VERY tall order these days.

October 17 2011 at 9:53 AM Report abuse +1 rate up rate down Reply

The government loves pointing its fingers at the banks. Are they going to make a law that says the government can't roll the dice with taxpayers money like they did with Solyndra? Hmmm. Yeah, the bank makes the loan, but the government pushes it. It also seems to me it was the government that created a law called Credit Reinvestment Act that FORCED the banks to make loans to people who couldn't afford them because the governement had to make sure EVERYONE could afford to buy a home. It's the American Dream. The government needs to keep its hands off of private industry.

October 16 2011 at 6:37 PM Report abuse -1 rate up rate down Reply
1 reply to jim39428's comment

The Foggy Bottoms goons spent decades professing the utopia they were delivering, otherwise known as "affordable housing".

Right up until housing became more "affordable". Then the goons search high and high low for a scapegoat upon whom they can blame for thehavoc they wrought.

October 16 2011 at 7:22 PM Report abuse rate up rate down Reply

As usual, the chickens have come home to roost. DID any Democrat think for one minute that adjusting swipe fees would help the consumer????????? All it did was pass on the fees to the poor working person. The rich retailer kept the money, Did any of you see a price reduction at the supermarket or department store?????? Wake up america, we live in a very selfish world. dog e dog. If you want free services from the major banks stop letting the federal government from running them. I personally enjoyed the use of free checking and a debit card for the last 20 years, how about you? End the Federal government intervention into private business. The Banks paid of TARP with a huge profit to the American Tax Payer. Get off their case and let's have a n economic recovery before we all go broke like Greece.
Signed American's for American's

October 16 2011 at 5:24 PM Report abuse rate up rate down Reply
1 reply to brrymor's comment

LOL The banks get near zero int rates from the Feds , then turn around and charge 15-20% int in credit cards and loans . Then they charge another fee after fee ! Last time i checked that a huge income for the banks . If banks are going broke like you think ? I have a bridge to sell you in NYC. < LOL BTW AIG did not pay a dime of tarp back 180 billion and counting . And a few big banks like BOA charged off the debt from tarp! Are you lost ? LOL Another fox news clone.

October 17 2011 at 1:31 AM Report abuse rate up rate down Reply

¬¬¬¬¬Natio­nal Debt Increased by 81% under Bush:

2001 - $5.871 trillion
2008 - $10.640 trillion

National Debt Increased 24% Under Obama:

Jan 31st 2009 = $10.569-Tr­illion
June 30st 2010 = $13.149-Tr­illion

But of the $2.6-trill­ion increase, 98% was carry over from Bush programs:

Bush: $607-billi­on = Interest on Debt 2009/2010
Bush: $240-billi­on = Iraq War Spending 2009/2010
Bush: $319-billi­on = TARP/Bailo­ut Balance from 2008 (as of May 2010)
Bush: $419-billi­on = Bush Recession Caused Drop in taxes
Bush: $127-billi­on = Bush Medicare Drug Program 2009/2010
Bush: $141-billi­on = Bush Medicare Part-D 2009/2010
Bush: $514-billi­on = Bush Tax Cuts 2009/2010

Bush's contributi­ons:

2001 to 2008: $4.769-tri­llion
2009 to 2010: $2.367-tri­llion
Total: $7.136-tri­llion

Obama’s share: 580 billion for stimulus spending as of May 2010.
Vote Republican for more of the same brutal beat down, serfs.

October 16 2011 at 1:21 PM Report abuse rate up rate down Reply
1 reply to Michelle's comment

While I'm no fan of Bush, I could suggest in 2009, Obama had the ability to curtail, defund any program enacted under Bush, including tax reform. But instead he choose Health Care, which it appear is going down! Obama continue most Bush policies you are so against!

October 17 2011 at 10:12 AM Report abuse rate up rate down Reply
1 reply to gpfs's comment

Republicans, also known as the "No" party, not only refused to cooperate in health care reform, also stone walled all other efforts, offered no jobs bill of their own, and their sole agenda according to Mitch McConnell was to make Obama a "one term President" from day 1. With cooperation like that, no wonder the working and middle class of this once great nation scream out with one voice: Occupy Wall St. & do away with the banker gangsters who have absconded with the American Dream & replaced it with nightmare for the 99%.

October 17 2011 at 3:43 PM Report abuse +1 rate up rate down

Based on what I hear the rule is very weak and allows the wall Street Thieves ways around it. So why did they not reinstated the Glass-Steagall. It worked since the 1930's. ANSWER: because the crooked Congress& the President (who removed G-S in 1999-is it any wonder the Clintons moved to NY) in hand with Wall Street own the country and do what they want. No third party --no solution.
I am glad I have no children to worry about--the rest of you---GOOD LUCK !

October 16 2011 at 9:52 AM Report abuse +1 rate up rate down Reply

A bank that can't make it rich today deserves to fail. Consider that the cost of money they borrow from the FR is less than 1% and they loan it our for 18 to 25% for short term loans and 4% for home loans. Their margin has never been better. The problem seems to be they feel the need to hang on to home loans that are under water instead of washing those out of their books. In spite of this they are still making inappropriate real estate loans with low or no down payment, based on inflated real estate prices, to people who have little or no insulation for loss of their income. There is more to this than just keeping the banks alive. We have evolved into a society that looks upon credit ratings where we once only a decade ago looked to our savings accounts.

October 15 2011 at 10:11 PM Report abuse rate up rate down Reply
1 reply to iiraandmkj's comment

The problem is that your average American , that is a fox cable news clowns , cannot add ! They truly have no clue on how the government works ? And will follow the republican or dem clones around! And re elect the same idiots to congress! Over and Over again ! Money rules , and the average American has no lobbyist in the House and Senate. When the SCOTUS said corporations are PEOPLE ? And money is FREE SPEACH ? LOL Funny , i read the constitution of the US and never once seen that ? LOL < The average American like you and I were and are TOAST. FIRE CONGRESS!!!! " America"

October 16 2011 at 9:31 AM Report abuse rate up rate down Reply
1 reply to milofilomay's comment

I'm all for firing congress as long as they make me King!! =)

October 17 2011 at 9:45 AM Report abuse rate up rate down

Its time for true capitalism ! Wall street today is a socialist entity ! The tax payers of the USA should not be insureing any investments on wall street from banks to investors ! Investing is a risk ! < Thats true capitalism ! What we have here is wall street on the government dole!

October 15 2011 at 9:59 PM Report abuse rate up rate down Reply

doesn't anyone understand the correlation between prosperity and the dollar based on silver? and the correlation between the decline of prosperity and the dollar based on nothing? just wondering?

October 14 2011 at 8:22 PM Report abuse rate up rate down Reply

why does no one listen to Paul Volcker and everyone listen to Greenspan and Bernanke?

October 14 2011 at 8:22 PM Report abuse rate up rate down Reply

The Volcker rule must come back. Since the banks, do not nor have shown that they have the will power to regulate themselves, then we must do it. Or FACE the fact that we will always be bailing them out. As this morning on Squak box...Sec of the Treasury in Paris, said, to the question about the European banks that " we must help to bail these banks"..when asked by how much, he had no idea but it was in the interest of the USA to bail out the banks in Europe too..now why hasn't that made the front page of the HP OR WSJ ??
No these bankers and their investment arma are playing with OUR money and who is going to cover our losses when they loose? No, close down the casino once and for all..

October 14 2011 at 5:45 PM Report abuse rate up rate down Reply