Dear Reader,
What happens to your money when you put it in a bank?
I remember when I was five years old, watching in awe from the passenger seat of our family station wagon as my mom put my dad’s paycheck into the plastic capsule at the automated teller. She’d place the capsule in the vacuum tube, press a button, and presto: the capsule would be whisked away, Jetsons style.
A minute or so later, the capsule would return with something for everyone: cash for my mom, a lollipop for me, and a biscuit for our cockapoo. Banks were awesome!
As a Casey Research reader, you probably know that (A) banks aren’t awesome and (B) banks don’t keep your money in a vault for safekeeping; they invest it. The much-awaited Volcker Rule that took initial effect on April 1, and will continue to phase in over the next couple of years, changes what banks are allowed to do with your money.
The Intent
The rationale behind the Volcker Rule goes like this:
Banks are FDIC insured—meaning taxpayers are ultimately responsible for any business-threatening losses a bank incurs.
Since banks receive this generous public subsidy, they should stick to activities that benefit the public—like collecting deposits, lending, managing the nation’s payment system, and other low-risk activities that grease the wheels of capitalism.
Therefore, banks should immediately stop engaging in exotic and risky activities—like trading with customer funds—because doing so allows them to rake in profits when their trading strategies work out and to stick taxpayers with the bill when their strategies blow up.
The case seems sound, and the logic has a certain linear appeal. Though I would vehemently argue that FDIC insurance is the root of the problem. Eliminate it, and depositors would have to (gasp!) learn about a bank before entrusting it with their money. Reputation would stop banks from making risky or fraudulent investments. Just like your dry cleaner doesn’t need a law to tell him not to loan out your jeans to another customer, banks that want to retain customers would treat your property with respect.
But I realize that the FDIC ain’t goin’ nowhere… so let’s analyze the Volcker Rule with that reality in mind.
The Volcker Rule aims to force every financial business to make a choice—to be a bank that collects deposits and makes loans, or to be an “other†financial entity that makes riskier investments. You can’t be both.
Economic history buffs will recognize the Volcker Rule as similar to the infamous Glass-Steagall Act, which separated traditional banking from investment banking. Contrary to popular belief, Glass-Steagall was not repealed by Bush, but was whittled down to impotency over several decades and finally put out of its misery by the Clinton Administration in 1999.
