Because of the Volcker Rule, your everyday banking is probably going to cost you more. There are likely to be higher fees of all kinds to be paid and bigger commissions collected for investment trading. Some fees will pay specifically for compliance activities, but even fees for routine banking services could go up. More importantly, the general cost for all money activities could very well go up, in the form of higher interest rates. Controlling big banks and reining in their risky business practices comes at a price.

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The Volcker Rule is the last element of the Dodd-Frank financial reform act passed in 2010 and regulators plan to implement it by next year. Its purpose is to prevent big banks from engaging in speculative trading activity. The banks and their allies are said to be lobbying mightily to delay enforcement and protect some of their most profitable lines of business.

Compliance, costs and criticism

While the impact of the Volcker Rule on consumers may be indirect for the most part, the cost to the banks for hiring thousands of compliance officers is nearly certain to result in higher fees to customers. And the cost of trading stocks may rise, too, leading to less efficient markets. To recoup these expenses, banks would again likely raise consumer fees and commissions. The rule’s most significant but most subtle effect could be on general interest rates and money markets because anything that makes the exchange of money more expensive almost certainly forces interest rates up.

The U.S. Chamber of Commerce contends the resulting losses to banks because of the rule and will have even broader economic damage than that done to your purse or my wallet.  It will translate, according to the Chamber, into higher costs of funds for companies wishing to invest in new plants and equipment, or research and development, or to hire additional workers.

The decreased efficiency of markets could also prompt investors to demand higher risk premiums, which could reduce the value of existing stocks, bonds, and other assets, even housing.

There will also be an impact on the international competitiveness of our banks, since the rule will restrict them and not their global competitors. The Chamber says this will further reduce bank profits, leading to more costs for customers, and possible losses of many high-paid jobs.

Failsafe for ‘too big to fail’

In exchange for these costs and losses, its proponents say the Volcker Rule will provide us with better security from another financial collapse and we’ll rest easier because of it. Whether or not you can directly trace our recent major financial failures (or near-failures averted by bailout) to proprietary trading by the big banks, they were involved. And trading could easily cause future problems for the “too big to fail” institutions.

The rule in and of itself probably isn’t enough to prevent every future crisis. Banks have the ability to get into trouble with investment strategies that have nothing to do with proprietary trading. But the rule will certainly keep banks out of some areas that have proven risky in the past and exposed them to losses. And it could block one route by which the biggest banks could come into danger of triggering another financial crisis.

The nexus money machine

Looking back, “proprietary trading” by big banks was illegal for a half-century under the Glass-Steagall Act passed during the Great Depression. But Congress repealed the law in 1999  just as the government was encouraging previously unqualified home buyers to sign up for low- and no-equity mortgages. These ever-shakier mortgages were mixed into ever-riskier securities which the big banks then invested in.

The banking-government-housing nexus drove a revolving money machine that gained momentum with ever more exotic sub-prime mortgages and ever easier qualifying. All of it helped inflate and overheat the housing bubble until it finally blew in what became the infamous financial meltdown of 2008. And we’ve yet to see the last of the “Great Recession” which followed.

The bottom line was the big banks used FDIC-insured money for their proprietary trading. So, when they lost, they could count on the government to back them up. And, because the banks themselves were vital to the economy, the government couldn’t let them fail.

During the post mortem, Paul Volcker, former Federal Reserve chairman and chief Obama adviser on economic recovery, argued that “banks are there to serve the public” and their investments “create conflicts of interest.” He proposed barring them from proprietary securities trading — let them buy stocks for their customers but not for themselves.

As for investment houses — Volcker proposed they could trade securities, but couldn’t use money that was insured by the FDIC. If they failed, they wouldn’t be able to drag the American economy down with them.

‘Glass-Steagall Lite’

While some say the Volcker rule goes too far, others warn it doesn’t go far enough. It’s vagueness and exceptions, they warn, “raise serious doubts about whether this framework will actually produce the significant changes in bank practices that we need.”

Economist Nouriel Roubini, who predicted both the bursting housing bubble and the recession that followed, refers to the Volcker Rule as “Glass-Steagall Lite.” Roubini wants a firewall built between big commercial banks and other financial services: “We need to go all the way and implement the kind of restrictions between commercial banking and investment banking that existed under Glass-Steagall.”

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