The New Banking Restrictions

To continue our discussion of the impending financial regulatory bill, there are several provisions that would limit the types of trading that banks could do - and presumably save them from themselves. Primary among these are the limits on trading derivatives, those securitized vehicles that can be very far removed from the original issues, to the point of being almost unrelated. These had gone largely unregulated before, so this would be the first federal oversight they receive. Derivatives would now be traded on public exchanges, removing some of the more shadowy elements that had grown up around them, and most of them would need to be insured, removing the possibility of huge losses.

The Senate version also calls for banks to be prohibited from buying and selling derivatives. A call for a complete ban on the infamous credit default swaps did not make it through to the final bill. The Senate bill also included a rule (the so-called Volcker Rule) prohibiting banks from putting investors' money into things like hedge funds. That wasn't in the House version, but since President Obama publicly called for such a rule after the House version passed, it's likely to survive into the final bill.

The purpose of all this is to refocus the business of commercial banks back to their core functions. The major banks shouldn't be too hamstrung by these rules, but one notable sidelight is that Goldman Sachs and Morgan Stanley reincorporated from investment banks to bank holding companies back during the financial meltdown, and they would have a horrible time complying with the Volcker Rule; it will be interesting to see how they're forced to react to it.