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Banks' Glass-Steagall Walls Quietly Rebuilt (Update 1)

Stocks in this article: GSMSJEFBACC

Updated with commentary from KBW in paragraphs two and 20.

NEW YORK (TheStreet) -- During the Occupy Wall Street protests last fall, it was not unusual to see signs urging the return of the 1933 Glass-Steagall Act.

But according to panelists at the Securities Traders Association of New York on Thursday, the landmark Depression-era law that separated commercial banks, securities firms and insurance companies, undone in 1999 by legislation known as the Gramm Leach Bliley Act, is now effectively back on the books. And on Monday, financial services-focused investment bank Keefe, Bruyette & Woods chimed in with its own argument that big bank breakups may not be far off.

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The difference this time around is that regulators and legislators are phasing the changes in gradually, according to Sean Owens, director at capital markets consultant Woodbine Associates.

Two of the key changes affecting U.S. banks come from the 2010 Dodd Frank legislation. Those include Title VII, which brings a host of new rules to previously unregulated derivatives markets, and the Volcker Rule, which places strict limits on banks' ability to make directional market bets. Another sea change comes from Basel III, Swiss-based international banking rules that will require banks to hold a larger cushion against possible losses.

The vast bulk of this new rulemaking is still in relatively early stages. Basel III will be phased in over several years. Many of the derivatives rules have still to be written. And a softening of Volcker, which was the main subject of Thursday's discussion, is likely, the panelists agreed.

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Still, even if Volcker is watered-down, they believe it and the other rules may fundamentally alter the financial services landscape so that the largest five U.S. securities dealers-- JPMorgan Chase (JPM), Morgan Stanley (MS), Bank of America (BAC) Goldman Sachs (GS) and Citigroup (C) exit businesses widely thought of as central to their operations.

Of course the major business these banks will exit, if they haven't done so already, is proprietary trading. Many prop traders at Goldman, JPMorgan, Morgan Stanley and Citigroup have already anticipated the rule and left the company to set up hedge funds.

More surprising and controversial, however, is the argument that these institutions will exit fixed income market making.

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A market maker is merely a go-between: buying a bond or some other product from one party and selling it to another. A proprietary trader, on the other hand, takes a directional bet on which way the market is headed.

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