By Colin Barr
August 5, 2010

Two weeks after it took effect, the Volcker rule is already sweeping Wall Street.

Morgan Stanley

is planning to reduce its stake in the FrontPoint Partners hedge fund it bought four years ago, the Wall Street Journal reported. The move comes as rival Goldman Sachs

considers spinning off, winding down or moving its proprietary trading desks, the paper said.

The Volcker rule, named after former Fed chief Paul Volcker (right), limits the amount of money federally insured banks can invest in riskier structures such as hedge funds and private equity investments and in trading with their own funds. The rule won’t take effect for several years, and banks could have as long as a dozen years to fully comply.

But even as they carp about the uncertainty introduced by the regulatory overhaul, the banks aren’t letting moss grow under their feet.

Morgan Stanley’s decision will reverse part of a hedge fund buying spree undertaken by former chief John Mack. He bought FrontPoint in 2006 for $400 million in a bid to bolster the firm’s asset management business.

But the deal hasn’t been a big money maker for Morgan Stanley, which now plans to take preferred stock in FrontPoint that will hopefully let it recoup its investment over five years.

The prospect of changes at Goldman and Morgan show the big impact of the Volcker rule, which was enacted last month as part of the financial reform despite much industry hand-wringing. But even with this flurry of activity, the job of making the financial system is just starting.

“The Volcker rule is a reasonable approach,” Kansas City Fed chief Thomas Hoenig said in a March speech. But he warned that to truly reduce risks to the taxpayer-funded safety net, the rule must be “strengthened by allowing regulators to impose capital requirements and concentration limits on the nonbanking subsidiaries of holding companies.” So far, that is a work in progress.

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