Academic

During our Dodd-Frank forum, none of us focused too much attention on the "Volcker Rule" provisions designed to keep our banks from engaging in risky proprietary trading with money that might need to be used to pay deposits, etc.  Of course, this was how we saw the world during the reign of Glass-Steagall, which basically separated the world into deposit-taking commercial banks and non-deposit taking investment banks.  The thought was that Dodd-Frank would recreate that world.  Except that it does it in a much different way.

A lot of commentary has been written on Section 619 of the Act, which sets prohibitions on proprietary trading and certain relationships with hedge funds and private equity funds.  The main concern is that Section 619 seems like it is prohibiting these activities for "banking entities," but then it lists permitted activites notwithstanding the prohibitions in the first section.  So, it is best to say that this risky activities are now regulated, but not prohibited.  So commentary centers on whether the limitations are meaningful, will they have unintended consequences, do they get to the problems in shadow banking, etc.

However, this weekthe news is filled with stories of how the big banks are reorganizing to comply with Section 619 and rules that may be promulgated under that section.  Morgan Stanley may spin off FrontPoint, it's hedge fund arm, and Goldman Sachs is weighing options for its own proprietary trading division.  So, the rules are having some effect.  But wait, Goldman and Morgan Stanley aren't really banks.  They aren't retail depository institutions.  Why don't they stop being bank holding companies and go back to being investment banks?

Because there is no such thing anymore.  And this is why I think Section 619 is more pervasive than others do.  Because it may regulate instead of prohibit, but it regulates a much broader swath of the field.  So, under Section 619, not only are "banking entities" regulated, but so are "nonbank financial companies supervised by the Board of Governors."  OK, so what does that mean?  If you wade back through the Act, through Section 102 and Section 210, you'll see that the Financial Stability Oversight Council gets to decide which nonbank financial companies will be supervised by the Board based on whether material financial distress of that company could pose a threat to the financial stability of the United States.  So, Goldman and Morgan Stanley have no choice -- they would probably be found to pose a threat.  And, smaller nonbank financial companies may not be off the hook either because the Council has six months to study and propose rules that might affect them as well.  So, the financial world isn't divided between retail commercial banks and investment banks any more.