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Weekly Market Digest: What is the Volcker Rule?

Data released on Friday showed the US economy growing at a 3.2% rate in the first quarter, exceeding expectations. The exceptional Q1 GDP growth was fueled by higher inventory investment, increased exports, and falling imports amongst other factors. This is a welcome sign amid weaker domestic demand as well as early 2019 fears of a slowing global economy.

Also, White House officials are pushing for an increase to the debt ceiling before other government deadlines come in to play in September and October, though a divided congress is complicating any meaningful progress. The government is poised to spend close to $1 trillion more than it can bring in through revenue, and per usual will issue debt in order to bridge the gap. The government’s outstanding debt affected by that ceiling is near $22 trillion. It’s important to note that while there have been relatively close calls in the past, the government has never failed to raise the debt ceiling in time to pay their bills.

Weekly Returns

S&P 500: 2,939.88 (+1.20%)
FTSE All-World ex-US (VEU): (-.56%)
US 10 Year Treasury Yield: 2.54% (-.03)
Gold: $1,286.10 (+0.83%)
EUR/USD: 1.1148 (-0.77%)

Major Events

  • Monday – US Markets kicked off a busy earnings week with companies such as Microsoft, Facebook, and Amazon reporting. A meeting between North Korean leader Kim Jong Un and Russian President Vladimir Putin was announced.
  • Tuesday – The S&P 500 and Nasdaq Composite hit record highs, supported by positive earnings reports.
  • Wednesday – Uber Technologies, Inc. announces it has chosen Citadel Securities LLC to act as their ‘designated market maker’ in their highly anticipated initial public offering.
  • Thursday – Microsoft hit $1 trillion in market value, becoming the third company to reach the milestone after reporting strong first-quarter results.
  • Friday – US economy (GDP) grows at 3.2% rate in the first quarter, outpacing expectations. S&P 500 and Nasdaq Composite hit new record highs.

The Volcker Rule

There has been talk lately about changes coming to the Volcker Rule, a controversial component of the ‘Dodd-Frank Act’ which was passed by Congress and President Obama in 2010. The changes being worked on are being widely supported by Wall Street as it aims to ease some of the rules and accounting standards placed on US banks.

What is the Volcker Rule? Before the 2008 financial crisis, big banks with federally backed deposit insurance were able to use their own money to engage in highly speculative investments in what is known as ‘proprietary trading.’ Prop trading, while formerly a very lucrative business with the potential for sizable profits, also posed a high-degree of risk to the financial stability of these banks should their bets go south, even to the degree of causing that bank to outright ‘fail.’ Most of us can still recall the large role these high-risk trades played in the 2008 financial crisis.

Of course when a large bank fails, it’s not quite the same as any other type of business going under. These banks handle the deposits of millions of individuals and institutions, so when they go down it sends ripples throughout markets and the greater economy.

In order to prevent banks from engaging in these high-consequence activities again, the Volcker rule was put in place in 2014 with banks being required to fully comply by July 21, 2015. Some key elements to this rule on large banks: No more proprietary trading of securities and derivatives, and no significant ownership in hedge funds or private equity funds. To be clear, these banks can still assist their clients in engaging in these trades or funds and ‘take some off the top,’ but using their own funds in a way that could again destabilize the greater financial system through these speculative trades is no longer allowed. Banks also must deal with stricter reporting requirements, though smaller institutions are meant to not have as high of a burden as the bigger banks.

Since its implementation, there has been wide-spread criticism of the rule from Wall-Street. In recent years, multiple Federal agencies have been leading efforts to reform certain elements of the rule that could lighten restrictions currently placed on US banks. While it appears some progress is being made recently, it may still be quite some time before significant reform comes to fruition.

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