Teeka Tiwari

Why Wall Street NEEDS 'Volcker Rule'

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Wall Street is all up in arms about the so-called "Volcker Rule." Named after its champion, former Federal Reserve Chairman Paul Volcker, this proposed rule would bring increased regulation to the financial services industry.

Volcker testified before the Senate Banking Committee Tuesday, asking them to consider the proposal, which is also backed by President Obama.

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This rule will attempt to split agency (handling customer orders) and propriety trading (also known as principal trading). The gist of the rule is that, if you accept deposits (as in being a bank), then you can only trade on behalf of customers. You cannot trade on behalf of your own firm's account.

From 1933 until its repeal in 1999, the Glass-Steagall Act prevented commercial banks from conducting securities business. There was a strict separation between commercial banking and investment banking.

This law was born from the utter financial devastation that the United States experienced after the 1929 stock market crash. Like 2008, the 1929 market was fueled by cheap money and 10%-down margin loans on stocks.

When the 1929 crash hit, more than 5,000 U.S. banks went out of business, in large part because the banks had gorged themselves silly, lending money against overly inflated stocks. Separating "plain Jane" commercial banking from the far-riskier world of the securities business was an attempt by regulators to strengthen the U.S. banking system.

And you know what ... it worked!

Will the 'Volcker Rule' Work?

We had Glass-Steagall for more than 50 years, and the markets operated just fine. Within 10 years of repealing the Glass-Steagall Act, the United States was brought to its knees.

Those guys in the 1930s knew what they were doing. They knew that the greed of the bankers would override common sense. They created the separation of commercial and investment banking to protect the country from the exact same shock that we have just gone through.

The Street is crying that the re-implementation of any rules splitting agency and principal trading will lead to illiquid markets. What they don't say is that excess liquidity has a history of leading to excessive risk-taking. The subprime debacle was directly caused by too much cheap money chasing too little return.

Each year, there is only a finite supply of money-making opportunities available. Now, don't get me wrong, it's a huge number. Hundreds and hundreds of billions of dollars are made by financial institutions all over the world, every year. So, there are a lot of money-making prospects present in the financial markets, but it does have limits.