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The Volcker Rule: Obama Proposes New Banking Regulations

This article was written by in Economy. 8 comments.

If President Obama is able to enact the new plan for banks called “The Volcker Rule,” the era of banks too big to fail should be over. Obama has been speaking with former head of the Federal Reserve, Paul Volcker, who is advising the President to adopt a plan different than those suggested by Treasury Secretary Timothy Geithner.

Although the Volcker Rule has parallels with the defunct Glass-Steagall Act that created a wall between commercial banks and investment banking firms, it doesn’t go that far. The repeal of the Glass-Steagall Act allowed banks and investment banks to merge, like J. P. Morgan & Co. and Chase Manhattan Bank in 2000. If the Glass-Steagall Act were fully brought back JPMorgan Chase would be required to separate its businesses again.

Under the Volcker Rule, banks would still be allowed to offer investment services to customers, but they wouldn’t be permitted to invest customers’ FDIC insured deposits for the company’s financial benefit. This plan would effectively reduce the risk that banks assume. The administration also intends to limit mergers and acquisitions in the financial industry, but the details have not been determined yet.

Is the Volcker Rule a good move? What can the government do right now to protect consumers and Is regulation necessary?

Published or updated January 21, 2010. If you enjoyed this article, subscribe to the RSS feed or receive daily emails. Follow @ConsumerismComm on Twitter and visit our Facebook page for more updates.

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About the author

Luke Landes is the founder of Consumerism Commentary. He has been blogging and writing for the internet since 1995 and has been building online communities since 1991. Find out more about Luke Landes and follow him on Twitter. View all articles by .

{ 8 comments… read them below or add one }

avatar Jackie

Wow, I have no idea how to even go about determining whether that’s a good idea or not, or what the potential effects might be. But it seems like there should be some sort of happy medium between allow banks to play fast and loose with money in their care plus the financial products they can offer, and tight regulation and control of every little detail. Hopefully the proposed solution is it.

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avatar Dave

I live in Canada whose banking system is considered a world leader. Our regulations are tighter than a virgin and I would’nt have it any other way. We were the only developed nation not to have a bank failure during the U.S. made recession. We were the last to enter the recession and the 1st out. I thank my banker every time she asks for more info because I know what she’s doing is ensuring what happened in the states will not happen in Canada.

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avatar Eric

sorry but that metaphor made me cringe..!

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avatar lynn

The metaphor you used is rather demeaning to women. Ouch, it just set us back 100 years.

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avatar mlathe

quote: they wouldn’t be permitted to invest customers’ FDIC insured deposits for the company’s financial benefit.

That seems odd. How could a bank take in assets if they can’t use them to invest those deposits? That is, they would not be able to make *any* money off those deposits? That doesn’t seem right. Perhaps they limit *what* it can be invested in, like only AAA bonds or something. (not that AA would been all that good, since a lot is now junk).

Ultimately this probably means that interest rates for money we put in banks are going to be lower than in the past.

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avatar Edwin

What Glass – Steagall did was enforce a separation between commercial banks and investment banks.

The key difference is that commercial banks are meant to be risk controlled institutions that help control a nations money in the form of taking deposits from people wanting to save and giving credit to people wanting to borrow. It’s also important to note that this borrowing is done for standard purchases like a car, a home, etc. This facilitates an efficient use of money and increases productivity. Commercial banks in turn make their money by in essence charging a middle man fee for their service.

Investment banks are similar in that they take money from people that want to save and give it to people who want to borrow. The difference is that the people that want to save are more interested in investing their money in hopes for a profit, which naturally comes with an increase in risk. Additionally, the people borrowing this money are doing so in a more speculative purpose such as starting a company. Investment banks are meant to be the intermediary for these more risky functions in that they will put up the money for an IPO and then take the capital instruments (stocks or bonds generally) and resell them to the lenders.

What the lack of Glass – Steagall does is allow the two banks to merge (as they did in the 80s) and the investment bank arm can use the funds that are gathered from the commercial bank arm for investment banking purposes (note: more risky). This puts a much higher risk into the institution as a whole which is passed on to the commercial bank.

And that’s where we come to today, the banks put too much emphasis on risky investments which caused them to fail. Had Glass – Steagall still been in place, the investment banks would have failed but the more important commercial banks would have been safe.

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avatar Ross

Edwin is dead on with all of this. The repeal of Glass-Steagall — for all of its pros and cons — put the American banking system in much riskier hands. While the term “risky” obviously comes with its own set of negative connotations, the consolidation of the two banking sectors was high risk, high reward. There was the potential for tremendous upside, but as we see in hindsight, there was also potential for tremendous strife.

If nothing else, it appears the administration is ready to remove that risk:

“It’s a game-changer because it is truly one step toward removing the casino from Wall Street, if you will.” (http://www.newsy.com/videos/change-of-plans-obama-shifts-focus)

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avatar jim

THe rule would not allow them to do risky speculative investments with FDIC backed assets.

From an Obama speech transcript: “It’s for these reasons that I’m proposing a simple and common-sense reform, which we’re calling the “Volcker Rule” — after this tall guy behind me. Banks will no longer be allowed to own, invest, or sponsor hedge funds, private equity funds, or proprietary trading operations for their own profit, unrelated to serving their customers. If financial firms want to trade for profit, that’s something they’re free to do. Indeed, doing so –- responsibly –- is a good thing for the markets and the economy. But these firms should not be allowed to run these hedge funds and private equities funds while running a bank backed by the American people.”

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