Why the Volcker Rule is the Single Most Important Financial Reform

Ignorance with power is about as dangerous as it gets. Enter thoughtless puppets attached to strings of powers...

"I care not what puppet is placed on the throne of England to rule the Empire, ... The man that controls Britain's money supply controls the British Empire. And I control the money supply."

These words were uttered in early 1800s London by then the most powerful banking financier in the world -- Baron Nathan Mayer Rothschild.

When we ignore history, we only set the stage for repeating it. From multiple sources, I am reading this morning that the Obama Administration continues to be engaged in a major fight with the Senate to enact the "Volcker Rule." Wall Street lobbyists have come out guns-a-blazing to shoot down the proposal. Republican Senator Bob Corker, one of the Senators who opposes the rule says that the rule was merely introduced by the White House to "satisfy populist anger against Wall Street and not because the White House thought it was good policy." Sorry, Bob, but five former secretaries of the U.S. Treasury support the Volcker Rule. Read history, dummy.

The Volcker Rule is THE key component of any significant financial reform of Wall Street. Failure to pass the Volcker Rule would be a tragic failure of leadership to respond to the financial crisis. To understand the importance of the Volcker Rule, we have to have a historical context and how proprietary investment trading emerged in commercial banks.

One of the causes of the Great Depression was commercial banks engaging in risky investment activity. This is problematic because risky investment activity typically entails a certain amount of leverage (debt) that is used to "juice" gains. Juicing gains is great when investments work out. But when investments turn the other direction, an investor (in this case, commercial banks holding deposits of businesses and individuals) that is over-leveraged will find itself in a world of hurt. When a commercial banking investor finds itself in a world of hurt, the deposits of other businesses and individuals are put at enormous risk of being wiped out entirely. This is what happened during the Great Depression. Following the collapse of the stock market, legislators responded by passing the Banking Act of 1933 (also known as the Glass-Steagall Act). Among other things, what the Act did was make it unlawful for commercial banking and investment banking activities to be done under the same financial house. This law remained in effect until 1999 when Republicans led the charge to repeal the Glass-Steagall Act. President Bill Clinton signed the repeal into law in November 1999.

Rewind one year from 1999 -- in 1998 the global stock markets witnessed one of the scariest events to hit it in more than a decade. What happened? Ever hear of the hedge fund Long Term Capital Management? No worries, few have. A great book tells the story of LTCM far better than I am able too -- "Inventing Money: The Story of Long-Term Capital Management and the Legends Behind It" written by Nicholas Dunbar. In a nutshell, LTCM was a hedge fund engaged in proprietary trading activity. Using computers and mathematical models and huge amounts of leverage (it was using a debt to equity ratio of 25-to-1... equivalent to what banks were using in 2007), LTCM was taking the investment world by storm by returning 40% per year through a four-year stretch in the 90s. Then came 1998, and a Russian bond crisis. When the bond market tanked, LTCM lost about 90% of its value in FOUR MONTHS!! Warren Buffett stepped in and organized a bailout effort of LTCM (read about the Panic of 1907 and you will find eery comparisons to J.P. Morgan bailing out Wall Street) so that LTCM's collapse would not lead to a trickle collapse of other Wall Street institutions.

Fast forward to 2007, and we find a Wall Street not too dissimilar from what we saw just prior to the Great Depression. Here, Wall Street banking institutions, empowered by the Glass-Steagall repeal, had formed hedge fund operations within each banking house. Basically, each major Wall Street bank now had their own LTCM. Basically, it was one GINORMOUS ticking time bomb.

With Wall Street banks over-leveraged at a ratio of 25-to-1, following the collapse of the real estate market and the derivative securities that accompanied them, banks had no way to pay off the enormous debt. Enter the federal government and the largest financial bailout in history -- the U.S. Government had to print off over $1 trillion in new debt to pay off the debts created by hedge funds of Wall Street banks... debt that you and I and every other taxpayer will be paying off for many, many years to come -- all because of GREED on Wall Street.

The Volcker Rule would put an end to this. The Volcker Rule would make it unlawful for banking institutions to operate in-house hedge funds.

This is THE ONLY financial reform that truly matters. Wall Street knows that and is fighting it like crazed dogs -- a sure sign there is real meat to the rule. The rule would mean no more proprietary trading in banking institutions, which would mean that banking institutions would not earn the kind of profits it has earned since the repeal of Glass-Steagall in 1999 -- it would also mean that the American taxpayer would no longer be required to bailout banks for failed trading activities.

Pass the damn rule, fools!

Peace

Jeremy