The Ottumwa Courier

AP National

December 11, 2013

How Volcker Rule would limit banks' risky bets

(Continued)

Q: Why does the Volcker Rule matter?

Because of the widely agreed-upon need to reduce the dangers that remain in the banking system. Proprietary trading has allowed big banks to tap depositors' money in federally insured bank accounts — essentially borrowing against that money and using it for investments, such as in mortgage-backed securities. When those bets soured during the crisis — especially after a wave of mortgage defaults — the banks were at risk of failing. Most survived only because of taxpayer-funded bailouts.

Q: So would banks be barred from investing the money I deposit?

A: The short answer is no. When people deposit money in a bank, they may expect the bank to use it for conventional safe investments, such as bonds. Those would still be allowed. But banks could no longer borrow against depositors' money to seek outsize returns on complex investments, like derivatives. Derivatives are investments based on the value of an underlying commodity or security, such as oil, mortgages, interest rates or currencies.

Q: How did the rule become so complicated?

A: Regulators found it hard to isolate what precisely distinguishes proprietary trading from, say, market-making. The line can be blurry.

Another challenge: No fewer than five agencies, including the Federal Reserve and the Securities and Exchange Commission, had to grapple with the rule and reach common ground.

If that weren't enough, industry lobbyists used their muscle to try to preserve the banks' trading operations. They won a round in 2011, when regulators approved a draft that exempted "portfolio hedging" from the trading ban. This meant banks could make trades for their own profit to offset the risks of either individual investments or a broader investment portfolio.

Q: What was the banks' argument?

A: They contended that a ban on proprietary trading could bar them from legitimate market-making on behalf of customers and from appropriately limiting their risks by hedging broader portfolios.

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