NEW YORK (TheStreet) -- U.S. regulators are finally implementing the Volcker Rule, and it may prove to be the hidden jewel in the Dodd-Frank financial reforms.
The rule limits bank purchases of stocks, bonds, currency, commodities, and derivatives -- contracts that bet on movements in the prices of assets -- with their own money, which also put their federally insured deposits at risk.
Financial behemoths such as JPMorgan Chase (JPM) earn huge profits from such proprietary trading. Those profits help pay huge bonuses for traders and also create great jobs for many ordinary Americans. Unfortunately, trading distracts attention from the ordinary business of taking deposits and lending money to small businesses and homeowners.
It sounds reasonable. Encourage banks to be banks again by pushing them toward lending by prohibiting trading, essentially making bets with deposits ultimately guaranteed by taxpayers.
During the financial crisis, however, securities trading didn't get the big Wall Street banks in trouble. In fact, the profits from trading kept many solvent when mortgages failed and later when the banks paid big fines for misrepresenting mortgages sold to institutional investors.
Prior to the crisis, banks made loans to finance homes buyers couldn't afford, and then bundled mortgages into bonds to sell to pension funds, insurance companies and other investors. When investors figured out many loans would fail, banks got stuck holding too many bad loans and mortgage-backed securities.
Once some mortgages failed, foreclosures snowballed and housing prices collapsed. </>Other complex arrangements, such as buying and selling derivatives intended to insure against too many mortgages failing, contributed mightily to the morass, but it wasn't JPMorgan trading in foreign exchange or Goldman Sachs (GS) buying and selling aluminum futures that caused the collapse. That trading stayed profitable, even for Citigroup (C), which headed the list of basket-case banks Uncle Sam had to rescue.