The subprime mortgage crisis and related recession of 2007-2008 profoundly influenced the US and the world. On top of the initial devastating impact, it took years of struggle and reforms to clean up the mess. One of the results was the so-called Volcker rule. Other major consequences of the crisis include a housing market full of foreclosures, reduced real estate values, crippled banks, the TARP bailout, rising unemployment, public outcry, and a depressed economy.
The severity of these issues caused legislators to implement changes to much of the financial system in the aftermath. The International Monetary Fund’s estimates put the total global losses from the subprime crisis at $4 trillion.
To ensure that this would never happen again, the Dodd-Frank Act Wall Street Reform and Consumer Protection Act was drafted and passed in July 2010. The long name for this act is An Act to promote the financial stability of the United States by improving accountability and transparency in the financial system, to end “too big to fail,” to protect the American taxpayer by ending bailouts, to protect consumers from abusive financial services practices, and for other purposes.
Enacting the Volcker Rule
To assist in recovering from the recession, President Obama formed the President’s Economic Recovery Advisory Board. This was a panel of experts with Paul Volcker as its chair. Volcker was a former Chairman of the Fed under Carter and Reagan. His significant contribution was the Volcker rule, stating that banks could no longer speculate with their client’s money. Volcker saw that allowing banks to do so had been a notable factor in the crisis. It was also tantamount to proprietary trading.
Such sweeping change was, of course, resisted at many turns. Banks did not want these rules potentially stifling their profits. Some legislators sought to weaken its aspects, often citing the need to save the good aspects of these banks engaging in proprietary trading. After seeing the first bill drafted, Volcker himself said: “I’d write a much simpler bill. I’d love to see a four-page bill that bans proprietary trading and makes the board and chief executive responsible for compliance. And I’d have strong regulators. If the banks didn’t comply with the spirit of the bill, they’d go after them.”
In the end, the final version of the Volcker rule was somewhat softer. Banks can still invest in private equity funds and hedge funds, with up to 3% of their tier 1 capital. They also had permission to invest in treasuries. Any other proprietary trading is banned. This makes the US’s banking system less likely to get out of control than it was before. Now when you venture out into the markets, you can rest assured that the big banks have somewhat less of a role in driving them.