Will Big Bank Stocks Be Affected By The Volcker Rule Or Is It Already Priced In?
James Dennin, Kapitall: Big bank stocks seem to be shrugging off the Volcker rule. Are they right, or being cavalier?
The financial crisis might seem a distant memory, and its greatest casualties – Lehman Brothers and Bear Stearns – are both long gone.
Read more from Kapitall: American Airlines and US Airways to Merge: Airline Stocks to Watch
However the legacy of the banking disaster is still being worked out. It was only yesterday that the Volcker Rule – created by former Fed Chair Paul Volcker to delineate between commercial and investment banks – was finally approved by regulators. Well, sort of. The effective date of the rule was actually pushed back to July 2015.
But the idea behind the Volcker rule is quite simple. It basically tries to prevent investment banks (whose capital is often insured in part by the Federal government) from making excessively risky trades with other people's money. In other words, it places a ban on what's called proprietary trading.
While this sounds complicated, it's really not. Usually investment banks make their money off commissions and fees. They provide advice or recommendations to clients – but traditionally it's their clients who are supposed to assume the investment risks. Regardless of whether an investment pays off, banks still collect fees, so this is both their largest and safest revenue stream.
Proprietary trading on the other hand is when banks trade securities themselves for direct gain. The important difference here is that while the Federal government has no obligation to insure the dollars of these banks' clients, it cannot allow one of the banks themselves to experience a capital crisis without jeopardizing the US economy.
Under the Volcker rule, proprietary trading is severely limited. Many banks have begun selling or spinning off some of their trading desks already. However in a surprising turn, big banking stocks don't seem to be much affected at all. Most of the big financial firms actually went up the day the rule was enacted.
The question is: is the Volcker rule already priced in? Or are banks being overly confident that they can handle record lawsuits, new regulations, and a meandering recovery all at once?