The Dodd-Frank Act may have been passed into law nearly seven years ago, but that doesn't mean it's no longer in the headlines. Case in point: Since the new presidential administration came into power, it's promised to deregulate the financial services industry, bringing the Dodd-Frank Act back into focus.
In this episode of Industry Focus: Financials, The Motley Fool's Gaby Lapera and John Maxfield discuss what this means for the Volcker rule, which limited banks' ability to operate like hedge funds.
A full transcript follows the video.
This podcast was recorded on Feb. 13, 2017.
Gaby Lapera: I want to move on to the next thing, which is the Volcker Rule, which I think a lot of people have heard about, but maybe don't understand. The Volcker Rule prohibits proprietary trading, limits the relationship between banks and hedge funds, and I believe it also prevents banks from trading certain types of assets. This proprietary trading is something that sounds like a buzzword, but it means something very specific, which is when the bank uses the bank's money to invest, instead of just facilitating investing for their clients.
John Maxfield: That's right. Banks can't go out and act like a hedge fund anymore, where you're going out and buying super risky assets. What they can do now is serve as market makers, which means you're just facilitating. So, let's say you're a Bank of America, for example, and you have these institutional investor clients like an insurance company that wants to sell a whole bunch of government bonds that it owns. You can't just sell $100 million worth of government bonds, it's not like buying and selling a stock. You have to have somebody who'll actually facilitate that transaction. So, it will sell those bonds to Bank of America, and then Bank of America will find a buyer for those bonds, so, it just facilitates that transaction. That's what market making is, and that's what the Volcker Rule limits bank's' role in the capital markets to.
Lapera: Right. And banks make their money from fees generated from that, and maybe a commission or something. But before, with proprietary trading, they were actually taking consumers' money, like deposits or whatever, and then investing in the stock market and saying, "Look how much money we made with your money!" And that leads to some very risky practices, like you saw before the recession, that ran his headlong into a concrete wall.
