Banks Crashed the Economy. Will These 300,048 Words Stop Them Next Time?

The rule's namesake, former Fed chairman Paul Volcker.  Photo: HarvardEthics.

The Volcker Rule was finalized on Tuesday, and its 892 pages (yes, 892 pages!) are intended to curb the banking activities that many see as the heart of the financial crisis that crippled the economy around the world. And many want to know if it will help protect our economy in the future.

The reason for Volcker
Taking a step backwards, the Volcker Rule is a part of sweeping regulatory legislation that seeks to limit certain types of short-term proprietary trading, which is effectively a bank trading for its own benefit -- as opposed to trading on behalf of clients to receive commissions -- and also limits the bank's ability to both invest in and have relationships with hedge funds and private equity funds.

Many have notedthat although the rule is intended to mean changes for the largest financial institutions like Bank of America (NYSE: BAC  ) and JPMorgan Chase, its biggest effects will come to those firms that are more exclusively involved in investment banking and trading functions, like Goldman Sachs (NYSE: GS  ) and Morgan Stanley (NYSE: MS  ) .

Finding the extent of the bank's gains on so-called proprietary trading is opaque, Bloomberg reports that the largest banks may have as much as $44 billion in revenueat stake as a result of the newest rule, with JPMorgan Chase leading the charge at a nearly $11.5 billion. Of course, as a Douglas Elliot of the Brookings Institute noted in a January 2012 testimony, "[t]he Volcker Rule [...] by increasing the costs for banks and decreasing their revenues, which will push them to find other ways to pass costs along to their customers."

Beyond the banks

Photo: Emmanuel Huybrechts

While attempting to determine the economic impact of the Volcker Rule on the banks, it is important to note: The ultimate intention behind the rule was not to hurt the banks' ability to make money -- although that may be a result -- but instead to ensure the soundness and security of the economy. Federal Reserve Chairman Ben Bernanke said simply, the rule "has the important objective of limiting excessive risk taking by depository institutions and their affiliates."

The ultimate question then becomes, will the newest regulations achieve that?

Consider that a story in September of 2008 from The New York Times began by notingit was not proprietary trading that brought down Lehman Brothers, but instead, "[s]ignificant losses [...] suffered from its part of the acquisition of Archstone-Smith, a national apartment portfolio, helped to bring down the investment bank, one of the most venerable firms on Wall Street." In addition, the collapse at Lehman resulted from its underwriting of subprime, low-quality mortgages that it then sold to investors, and its immensely debt-loaded and highly leveraged position.

Would the Volcker Rule have prevented those? Perhaps. However, the Archstone deal was not a private equity investment but instead was a pure acquisitionfrom Lehman in conjunction with Tishman Speyer. And of course, no one would've thought Americans buying homes would devastate one of the most valuable companies in the world.

Its ultimate outcome
We must always know that while regulations will have both positive and adverse on all sorts of people, as Bernanke so aptly puts it, "the ultimate effectiveness of the rule will depend importantly on supervisors, who will need to find the appropriate balance while providing feedback to the Board on how the rule works in practice."

To this end, we must see that while the rule is in effect, its ultimate success will not depend on the massive cluster of papers, but on the individuals -- both at the biggest banks and the Federal regulators -- that ensure its policies are being adhered to.

We must also remember that while we may at times think the banks do not operate with the best interests of the public in mind, as Wayne Abernathy of the American Bankers Associationnotes, "from banks largest to smallest, there's a real desire to be able to focus their resources, focus their energies on funding job creation, funding development of the economy, meeting the needs of their customers."

The rule and the two-and-a-half mile-long string of text will not prevent the next crisis, but instead it is the individuals who operate with the best intentions of their best customers in mind who will. Indeed, as Foolish investors, that is what we must hope for from all companies, and not simply those on Wall Street.

The one bank to trust
Many investors are terrified about investing in big banking stocks after the crash, but the sector has one notable stand-out, and the Volcker Rule may not affect it in the slightest way. In a sea of mismanaged and dangerous peers, it rises above as "The Only Big Bank Built to Last." You can uncover the top pick that Warren Buffett loves in The Motley Fool's new report. It's free, so click here to access it now.

Read/Post Comments (3) | Recommend This Article (2)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On December 15, 2013, at 11:19 AM, Rusty56 wrote:

    Commercial Banks did NOT crash the economy. I can't inept people not understanding what they are writing about - ridiculous!

  • Report this Comment On December 15, 2013, at 4:13 PM, duuude1 wrote:

    Agreed - banks alone did not crash the economy. We all did it together. Bought a house during the crazy run-up from 1990s-2006? You helped. Sold a house to someone who couldn't afford it? You helped. Sell a mortgage without checking if the buyer could afford it? You helped. Package mortgages into securities while hiding the poor quality of underlying loans? You helped. Bought mortgage securities without understanding the quality of the assets backing the loans? You helped. Assess a home for more than it was worth? You helped. Refinance your home so you could spend the cash on stuff or vacations and ignore the balloon payments or otherwise ignore the fine print? You helped. We all had a hand in this.

    BUT - banks by virtue of their central role in handling all of these mortgages, packaging them, selling them, then kicking homeowners out without due process - they own the most responsibility. They have the power - so they deserve the proportionate amount of blame.


  • Report this Comment On December 16, 2013, at 10:47 AM, multi007 wrote:

    OMG BANKS DID NOT CRASH THE ECONOMY! If you bought a house you could not afford and then decided to stop paying on your obligation, YOU crashed the economy!!!

    Stop blaming the banks and start blaming the dead beat debitors.

    PS. Im long Jan. 2016 BAC calls - $15 strike. My opinion is that you be long this too.

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