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U.S. banks will be barred in most cases from trading for their own profit under a federal rule approved Tuesday.
The Federal Reserve and the Federal Deposit Insurance Corp. each unanimously voted to adopt the so-called Volcker Rule, taking a major step toward preventing extreme risk-taking on Wall Street that helped trigger the 2008 financial crisis.
Three other regulators were expected to follow suit Tuesday.
Congress instructed regulators to draft the rule under the 2010 financial overhaul law.
The rule was agreed to after three years of drafts, debates and lobbying by Wall Street banks.
The final version is stricter than many had expected and is intended to prevent risky trading that required taxpayer-funded bailouts during the crisis. But the rule still provides some exemptions.
At its heart, the rule seeks to ban banks from almost all proprietary trading. The practice of trading for their own profit has been very lucrative for big banks like JPMorgan Chase, Bank of America and Citigroup. The rule also limits banks’ investments in hedge funds.
Still, the final version allows proprietary trading when it is done to facilitate buying and selling investment for customers. That is known as market-making.
Also exempted from the ban are cases when a bank underwrites a securities offering, and for trading in U.S. government, state and local bonds.
ROBIN YOUNG, HOST:
From NPR and WBUR Boston, I'm Robin Young.
JEREMY HOBSON, HOST:
I'm Jeremy Hobson. It's HERE AND NOW. Regulators from five agencies are set to approve the Volcker Rule today. It's one of the most important reforms of the 2010 Dodd-Frank Wall Street Reform Law enacted in the wake of the financial crisis five years ago.
YOUNG: Its aim is to restore that firewall between ordinary, everyday banking and the kind of high risk financial betting that used to be separated by the Glass-Steagall Act which was shot down in 1999. NPR economics correspondent John Ydstie is with us and, John, we know it's named after former Fed Chair Paul Volcker but what else does this rule do? Talk about proprietary trading.
JOHN YDSTIE, BYLINE: Well, there are a couple of goals here. One is to get banks not to engage in risky behavior that could cause their failure and wreak havoc with the financial system. The other is not to allow them to use funds insured by the government and backed by taxpayers to do that. So banks will not be allowed to use those kinds of funds to trade securities, stocks and bonds for their own profits. That's what's called proprietary trading.
That's a huge deal for banks because right now proprietary trading is a vast source of revenue for Wall Street. So banks have been fighting hard against this rule. As it turns out, they've managed to weaken some parts of it but it's still pretty tough.
YOUNG: Well, but there are exceptions to the rule, including something called market making. Explain that.
YDSTIE: Right. Right. Banks will be able to buy and trade securities for their customers and they'll be able to trade securities as a hedge against risks. The problem here, though, is that it's very tricky figuring out whether any given trade is a hedge or simply an attempt to make a profit. So the Volcker Rule, released today, says that any trade has to be tied to a certain asset and to be defensible as a hedge designed to reduce one or more specific identifiable risks.
Like currency risk or interest rate risk or market risk. The rule also bans something called portfolio hedging which can involve a huge variety of assets. And that's what JP Morgan Chase was doing in the London Whale case in which it made huge speculative bets and lost $6 billion. That kind of trading will be banned.
But there are some exceptions. Banks will also be able to trade federal, state and municipal bonds for their own profit. But they'll be barred from speculative activity like owning private equity funds or hedge funds.
YOUNG: Well, you just said a lot there and I can see someone scratching their head. You know, you said maybe these are tougher rules than Wall Street wanted. What does it mean for me if I've got my money in a bank? What does it mean for the average consumer?
YDSTIE: Well, I think it means that your money is safer and it's less likely that one of these big banks is going to get itself in trouble and fail and be a burden to taxpayers. That's really - the goal here is to make the financial system much more safe and stable.
YOUNG: And where does this - you know, put it in perspective. What does it mean where we are in regulating financial markets?
YDSTIE: Well, I think, you know, I think we've made some progress in the last year. I mean, two-thirds of the 400-some rules included in Dodd-Frank have yet to take effect but getting the Volcker Rule completed is a sign of progress, I think. Just last week Treasury Secretary Jack Lew suggested we have made significant progress in ending too big to fail this year and making financial systems safer.
That said, you know, a huge complex system like our financial system is never going to be completely safe.
YOUNG: That's NPR economics correspondent John Ydstie on that kind of a downer note.
YOUNG: You know, it's a buyer beware cautionary note.
YDSTIE: That's right.
YOUNG: Yeah. Yeah. John, thanks so much.
YDSTIE: You're welcome.
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