In 1999, President Bill Clinton repealed Glass-Steagall as a concession to big banks. The argument was that the rule had become extinct and largely unnecessary. Ten years later the media blamed the Great Recession on a host of financial deregulation policies including the repeal of Glass-Steagall.
On February 9, 2015 SEC Commissioner Kara M. Stein was in Tokyo, Japan to attend the International Organization of Securities Commission (IOSCO) Board Meeting in Seoul. While there she gave a speech about the changes in the U.S. financial system brought on by the Volcker Rule.
The Volcker Rule is the legal separation between consumer banks and proprietary trading. The rule is more exhaustive than Glass-Steagall, covering things like swaps, securitized entities and offshore accounts. The Volcker Rule, also described as "Prohibition and Restrictions on Proprietary Trading and Certain Relationships with Hedge Funds and Private Equity Funds", was originally proposed by Paul Volcker, former Federal Reserve Chairman, and was later brought to life in the Dodd-Frank Wall Street Reform and Consumer Protection Act. It applies to U.S. banks anywhere in the world and it has teeth because it's enforced by the SEC; banks have until July 21, 2015 to be in compliance.
"Banking traditionally has been an honorable profession," Stein tells the audience,
and bank professionals should be able to take pride in helping to provide capital to growing businesses or successfully managing investors' money. Frankly, I believe there is a genuine desire among most bankers to regain the public's trust and respect. But to do that, bank CEOs and Boards of Directors need to continue to rethink and re-envision their mission, as well as the incentives of their firms that encourage excessive risk-taking.
And this is the main communication and observance on the Volcker Rule by advocates. It is not meant to be a catch all to eradicate risk in the market -- its goal is to discourage excessive risk-taking.
Critics of the Volcker Rule believe it puts the U.S. financial system at a competitive disadvantage by pushing prop trading to less regulated markets. Steins answer to this rationale is, "...competition is better served by preventing an over-concentration of activities within large 'universal' banks." And, goes on to say, "...strong regulation has long been a source of competitive strength for the U.S. financial system."
Why did Stein decide to give this speech in Japan? "Given our shared history when it comes to the separation of commercial and investment banking, I thought that being here in Japan would offer a good opportunity for me to share a few thoughts on the Volcker Rule", Commissioner Stein told her audience. Japanese banks are also worried that the Volcker Rule may prohibit interaction with hedge funds and private equity funds that have U.S. connections. Another concern is how the Volcker Rule treats the foreign equivalent of mutual funds and whether or not seed funding, i.e. $5 million or so, can still take three years to develop a track record without asking for regulatory approval.
Ultimately, the goal of the Volcker Rule is to improve resiliency without sacrificing competition or liquidity. It focuses on stability by purportedly 'disconnecting connections' that made previous bank runs so contagious. It's hard to say what the impact of the rule will be on financial markets, foreign investment, or the world's largest bank holding companies in terms of compliance, but we'll all know soon because it'll be here in just a few months.
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