banking

Fed faces intense criticism over bank rule

But beyond concerns about falling profits and lost jobs, banks raised a number of issues about how the rules would affect international markets for bonds, derivatives and other types of investments. That's because many banks perform a function called market-making, which is essentially acting as an intermediary between buyers and sellers, Barth says.

Sometimes at the moment a seller wants to unload a particular asset, there are no willing buyers, and vice versa. That can cause large spikes or crashes in the value of an investment because a lack of either buyers or sellers can temporarily send the price of an asset up or down as the few willing buyers and sellers drive a harder bargain, Barth says. Market-makers smooth out those spikes by buying assets and temporarily holding them until willing buyers show up.

Should banks no longer be allowed to engage in market-making, the cost of investing in some types of securities, particularly bonds, will likely go up for consumers because as liquidity shrinks, transaction costs go up, Barth says.

In the end, that could mean higher expense ratios for bond funds and other investments, affecting returns for individual investors over time, he says.

The other major objection is the cost and complexity of complying with the rules. They say the line between proprietary trading and trading on behalf of clients is often blurry, and that it will be difficult to determine whether a trade will run afoul of regulators until after the fact.

A word from consumer advocates

Some of the critical letters sent to the Fed ran in the other direction, with consumer advocates and Wall Street critics expressing criticism over the profusion of loopholes in the rules. Americans for Financial Reform, a coalition of labor, investor, civil rights, community, small-business and senior citizen organizations seeking comprehensive financial reform, wrote one such letter.

"In the proposed rule, the regulators have not placed the statutorily required limitations on permitted capital market activities. Instead, they have gone to some effort to preserve business as usual in important areas," the coalition says.

Those advocates were joined by a flood of more than 16,500 form letters sent by consumers pushing for the Fed to implement the Volcker rule without any further industry-friendly loopholes.

For his part, the 84-year-old Volcker published a long and detailed defense of the rules.

"The comfort for creditors and others inherent in the ability of institutions engaged in proprietary trading to resort to the federal 'safety net' can only tend to encourage greater leverage and risk-taking. Commercial bank proprietary trading is thus at odds with the basic objectives of financial reforms: to reduce excessive risk, to reinforce prudential supervision and to assure the continuity of essential services," Volcker wrote.

Ultimately for regulators, the decision with how strict or accommodating to make the rules will come down to a cost-benefit analysis, Barth says.

"If it turns out these costs go up to all sorts of investors and people who buy and sell securities, and there's less liquidity so the costs are higher, what are they getting in return?" he asks. "Are they really getting, for the money that they're paying, a much less risky banking system? Have systemic risks really declined much?"

The comment period on the Volcker rule ended Monday, Feb. 13. The Fed will take those comments into account as it fine-tunes the rule and issues a final version. It's scheduled to take effect July 21.

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