The news of the day is the announcement of an impending White House proposal to reform the US financial markets, much of which will follow the now so-called “Volcker Rule”. There are 2 main guidelines of this rule:
Limit the Scope - The President and his economic team will work with Congress to ensure that no bank or financial institution that contains a bank will own, invest in or sponsor a hedge fund or a private equity fund, or proprietary trading operations unrelated to serving customers for its own profit.
Does this help in limiting risk in the market? Ok, to simplify this, let’s go back to the steel company analogy from my last post (I know this is beating up on shaky analogy, but still, if you haven’t already read the post, you should, to understand what my point here is.)
11. So it turns out that the steel company, aside from making a ton of money selling overvalued steel, also happens to have a small purchasing office that had been purchasing hand fans and rubber tires, also purely for its resale value, and it also happened to lend some money to other buyers with the same objectives. Their activities have inflated the price of hand fans so much that people of more meagre means were now sweating like pigs in the summer heat.
12. With the new Volcker rule, it will have to shut down that purchasing office. Oh well, the steel company will just need to content itself with profits from flooding the market with toxic steel.
Limit the Size - The President also announced a new proposal to limit the consolidation of our financial sector. The President’s proposal will place broader limits on the excessive growth of the market share of liabilities at the largest financial firms, to supplement existing caps on the market share of deposits.
13. But wait, with the new Volcker rule, too, the steel company will now have to limit its use of iron ore. That should limit the number of steel going out into the market, right? So now who are those people getting out of the steel plant? That’s right, they’re existing employees out to start their own steel plant. No sense letting all this good ore go to waste, don’t you think?