An Explanation of the Volcker Rule

The Volcker Rule is a proposed law first proposed by Economist Paul Volcker, former Federal Reserve Chairman, and endorsed by President Barack Obama. It limits the ability for commercial banks to engage in speculative trading. The Volcker Rule would end all "Investment Banks," making banks choose between servicing retail customers or investing in the market. Banks would still be able to invest on behalf of clients, but they would be restricted from owning or investing in hedge funds, private equity funds or exposing themselves to other types of liabilities.

Reason for the Volcker Rule

The Volcker Rule was first proposed in January of 2010, just a few years after the market collapsed under the weight of a systemic problem in the nation's banking system. That problem, though it has been blamed on many different elements in the economy, highlighted specific actions banks took that lead to the collapse. One critical mistake many banks made was engaging in predatory lending, issuing bad debts they had reason to believe would not be repaid. Another critical error was engaging in speculative buying and trading of investments, including credit default swaps and other loan derivatives. The combination of bad loans and bad investments rendered an unprecedented number of banks insolvent. The Federal Reserve had to take over these banks to rescue them from debt.

Proposal of the Volcker Rule

President Obama's Economic Recovery Advisory Board began reforming the lending and banking system in order to address the inherent problems that were exposed in the financial crisis. President Obama relied on suggestions from top advisors, and he appointed Volcker as Chairman of this board. The proposal for the Volcker Rule came nearly a full year after the board was created. Even though the rule was endorsed by a number of prominent economists and members of Congress, it was not passed. Over six months later, Congress was working on a diluted version of the bill that could achieve passage.

Implications of the Volcker Rule

If the Volcker Rule passed in its entirely, the implications for the banking system could be unprecedented. Many opponents to the rule note banks must engage in some speculative trading in order to increase their capital assets and continue to make loans at high levels. Without the ability to invest their money, banks would be limited only to making profits from normal banking activities. This means many banks will raise rates on standard banking services such as checking accounts, online banking and even standard statements. Critics are quick to point out the result of any increased regulation in this area would be transferred to the public.

Even with these critics, supporters of the Volcker Rule say it is necessary in order to reduce the liabilities banks are legally permitted to expose themselves to. This is reasonable, according to supporters, if the banks wish to continue receiving insurance through the Federal Deposit Insurance Company. Ultimately, supporters of the proposed change say the FDIC should not have to pay for too much speculation on behalf of the nation's financial institutions.


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