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Volcker Rule Hurts Wall Street, Bankers Warn

Paul Volcker

First Posted: 02/13/12 05:56 PM ET Updated: 02/14/12 10:41 AM ET

It will hurt big banks and small banks, foreign banks and domestic banks, state and local governments, big corporations and the poor. It may well make your whites less white and your colors less vibrant.

These are just some of the potential horrors of the so-called Volcker Rule, at least according to months' worth of financial-industry comments to federal regulators implementing the controversial bank reform.

Monday was the last day for the public to comment on the Volcker Rule, which restricts banks' ability to trade with their own money, also known as "proprietary trading." Named for former Federal Reserve Chairman Paul Volcker, the rule is part of the Dodd-Frank financial-reform act and is meant to keep banks from taking big risks that wreck the financial system. Critics say it is a regulation too far and will create more problems than it solves.

Volcker on Monday defended the rule, boiling the criticisms down to a handful of general themes. But the criticisms -- mostly from the banking industry, which has dominated meetings with regulators during the discussion period, HuffPost's Ben Hallman noted last month -- are more varied than that.

For example, some critics suggest the rule will limit the number of people who can trade certain financial instruments, like corporate or municipal bonds. This will lead to the disappearance of what traders call "liquidity," meaning financial instruments will trade more sporadically, possibly increasing volatility and costs.

Citigroup warned this lack of liquidity would hurt already cash-strapped state and local governments.

"Without the liquidity provided by municipal securities dealers, municipal issuers would undoubtedly experience an increase in their financing costs," Citigroup wrote. "In light of the structural budget problems already faced by states and other municipal issuers, Citi believes that higher financing costs could have a material and adverse effect on the financial condition of such issuers and their securities. For this reason, Citi urges [regulators] to carefully evaluate the effect that the final version of the Volcker proposal will have on the municipal securities market."

Volcker dismissed the "liquidity" argument as beside the point -- better market liquidity did nothing to stop the financial crisis in 2008.

But some of the rule's critics argue that thinner trading will force banks to find other ways to hedge their risks, which they claim could raise the risk of another financial crash.

For example, the California Public Employees' Retirement System, the biggest U.S. pension fund, says it worries that a decline in bank proprietary trading will increase the volatility of the corporate bond market and lead to the use of dreaded credit-default swaps, the derivatives that helped crash the economy, and cause "unintended risks" as trading moves to alternative markets.

"We believe that a decline in bank proprietary trading will increase the volatility of the corporate bond market, especially during times of economic weakness or periods where risk-taking declines," the pension fund, known as Calpers, wrote. "Portfolio managers will increase their use of CDS to reduce economic risk to specific bond positions as the liquidation process of cash bonds takes more time."

U.S. Bank, meanwhile, said it is concerned about the rule's impact on its "ability to participate in low-income housing" and other tax-credit programs. The bank said it also worries the rule may make it harder to live up to its obligations under the Community Reinvestment Act, which encourages banks to meet the credit needs of low and moderate-income communities.

In 2011, the U.S. Bank was the seventh-largest affordable housing lender in the country, with $725 million in such loans.

Foreign banks also are trying to make their voices heard. The Norinchukin Bank in Japan wrote that the Volcker Rule is "essential" for preventing a repeat of the 2008 financial crisis. But it also said that foreign banks should be exempt. To prevent foreign banks with U.S. offices from proprietary trading "seems an excessive and extra-territorial application which deviates from one of the main objectives of the Dodd-Frank Act, namely, containing systemic risks," the Japanese bank wrote.

George Osborne, the United Kingdom's chancellor of the exchequer, also warned that over-regulating foreign firms could "disincentivize transactions" with U.S. firms. "This may encourage a migration of market-making to outside the regulated banking sector," he wrote.

At the same time, U.S. critics charge that the rule will hurt U.S. banks' ability to compete with foreign banks.

JPMorgan's chief executive Jamie Dimon, in an interview with Fox Business Network on Monday, said regulators need to be careful not to "destroy" U.S. capital markets or let it "go overseas."

On monitoring hedging risks through trading, Dimon said, "For every trader, we are going to have to have a lawyer, compliance officer, doctor to see what their testosterone levels are, and a shrink -- what is your intent?"

There is no Volcker Rule comment letter from JPMorgan Chase online.

The New York Stock Exchange also warned that the Volcker Rule could discourage business investment and give an incentive to corporations to sell their debt in foreign markets.

The top recipient of venture capital campaign contributions in the House, Rep. Anna Eshoo (D-Calif.), said in her letter that she strongly supports the Dodd-Frank Act and the inclusion of the Volcker Rule but for one thing -- the rule applies to venture capital firms.

Eshoo, who has received almost $67,000 in campaign contributions since 2009 from venture capital firms and was honored in 2010 as the first lawmaker to receive the National Venture Capital Association's American Spirit Award, said in her letter to the SEC that she "urges you to clarify that banks may continue to invest in venture capital funds and that these investments are not restricted by the Volcker Rule."

On behalf of the Securities Industry and Financial Markets Association, the consulting firm Oliver Wyman issued speculative numbers as to how much money corporations and investors would lose as a result of the Volcker Rule. The group made its calculations based on the assumption that the Volcker Rule would lead to less investment, though the claim still is controversial.

Oliver Wyman, a management consulting firm, wrote that corporations would have to pay $12 billion to $43 billion more per year to borrow, and that investors would have to pay $1 billion to $4 billion more per year because the debt would be harder to turn over. Oliver Wyman's reasoning is that debt becomes more expensive when there are fewer investors willing to buy it.

These costs are small even by Oliver Wyman's admission, constituting just a fraction of the nearly $1 trillion in corporate debt issued each year, according to the firm.

The Metropolitan Life Insurance Co. cited the Oliver Wyman study in its own comment letter claiming that the supposedly higher costs of borrowing could be "prohibitive" for some firms. This could cause less investment and hiring, MetLife speculated.

The Wisconsin Bankers Association complained that the Volcker Rule would lead to higher costs for local banks, by forcing them to hire more lawyers. It threatened that the banks could pass on those costs to consumers.

"The proposal will result in substantial costs which will increase costs to financial institution customers, and will likely result in the reduction of current available services," the Wisconsin Bankers Association wrote.

Laypeople not from Wall Street also submitted comments -- largely in favor of a strictly implemented Volcker Rule.

Randy Childers, writing from Kansas, said that he wants banks "to be boring and dependable -- a utility, like how I get my water. What they're doing now is more like getting on a bus, and then realizing that it's some sort of freaky unregulated test vehicle that has a tendency to kill random passengers."

Marc De Puy, writing from New Mexico, said that he supports "a strong Volcker Rule" and that repealing the Glass-Steagall Act, which separated investment banking and commercial banking, was "a big mistake."

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