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Study: Volcker rule to be costly

By Sheyna Steiner ·
Friday, January 13, 2012
Posted: 11 am ET

Not surprisingly, this election year will shape up to be an ideological battle royal between proponents of free-market capitalism and those that would impose some constraints on unfettered capitalism in the form of regulation.

Back in 2010, the Dodd-Frank Act was passed in order to address some of the abuses by financial institutions that led to the financial crisis. Getting the bill passed turned out to be the easy part; instituting the vast array of rules has become more of a challenge. Between underfunded regulatory agencies and political squabbles in Congress, it's been slow going.

When considering new regulations, government agencies or regulators typically invite comments from the public and the industry. The comment period for one of the more well-known rules, the Volcker rule, ends today.

The rule would limit the amount of trading banks are allowed to do in their own accounts. By disallowing speculative investments, banks would be limited in the amount of risk they could take on. Instead of striving to profit from investments, regulators say, banks should focus on the business of banking, not making outside bets on questionable assets.

Conflicts of interest would also be minimized by separating consumer banking from investment banking activities.

It sounds good, but opponents say there will be unintended consequences including reduced liquidity in the corporate bond market and increased transaction costs for consumers.

One recent study by the consulting firm Oliver Wyman attempted to quantify some of those costs.

From the study, conducted for the Securities Industry and Financial Markets Association:

Our analysis is limited to clear first-order impacts, including

  • Mark-to-market decrease in value on existing bonds due to loss of liquidity.
  • Higher interest rates paid by corporate bond issuers, due to investors demanding greater liquidity premia.
  • Increases in transactions costs paid by investors, directly due to trading lower liquidity instruments.

The study estimates that investors could see a potential mark-to-market valuation loss of $990 to $315 billion.

As well, on an ongoing basis, "issuers will have to pay higher yields on new debt raised to compensate investors for holding less liquid assets," the study says.

The estimated annual costs to issuers is $2 to $6 billion in the first year and $12 to $43 billion after all outstanding debts have been refinanced at the higher rate.

Finally, the lack of liquidity will cost investors to the tune of $1 billion to $4 billion, the industry-sponsored study found.

What do you think?

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January 21, 2012 at 1:57 pm

Simone, are you kidding? The ultimate goal of unregulated capitalism is not free markets. It is monopoly control of markets. There is no company that ever existed that said "gee I hope I get some competitors for my customers' business and I hope someone comes up with a way to make my products better and cheaper so I have to work harder to improve and/or cut my prices" No, every company wants to control it's own market and pricing. And would lie, cheat, steal and do any other thing, moral or not, to achieve that end. There was never an investment bank that said "Although I know there's no law or regulation forcing me to do it, I would never fail to tell an investor about all the risks he takes by buying investments I'm promoting or by getting loans I'm offering, even though my competitors don't reveal those same risks." The only way to get a fair, level playing field, is to have an outside party refereeing the behavior of the actors in the particular market and enforcing the rules necessary to TRY and achieve that mythical level playing field. When we get disasters like the housing disaster or the savings and loan scandals years ago, it's only a sign that the rules (regulations) weren't strong enough and/or the referees (regulating agencies) didn't do their job enforcing the existing rules. Capitalism requires the level playing field to function. Without that, it isn't capitalism, it's monopolism.

Sheyna Steiner
January 17, 2012 at 9:08 am

That's a pretty strong statement Simone. Many people actually say that the financial crisis was born in part thanks to regulatory failures, not the mere existence of regulations.

The problem is not that we have too many regulations, the problem is that across industries, regulators are in bed with the industries they are meant to oversee. Case in point, the abject failure of ratings agencies to evaluate the risk of investments floated by big investment banks.

Not only is not enough money devoted to keeping industries within the bounds of the law and common sense but there is no energy to shut the revolving door between business and industry.

The inherent evil of regulations on capitalism is a popular line. Maybe if corporations were not bent on wringing out maximum profits on a per quarter basis at the expense of people and the environment there would be less of a need for regulations.

January 16, 2012 at 2:13 pm

Some constraints on unfettered capitalism = regulations , don't we have a mllion of these, Oops mrs Steiner , you like more of them ? Did they help , in housing, financial and other Bubbles - certainly not ! And never will , what it definitely does it slow job creation and business development in free market society , of course in socialistic society it's different , but the question still remain - do we want socializm in USA? It never worked anywhere !

Sheyna Steiner
January 13, 2012 at 3:21 pm

Agreed Charlie.

I think some constraints on reckless, short-sighted behavior is warranted myself. If only it didn't seem so much like closing the barn door after the horse is a mile down the road.

January 13, 2012 at 3:15 pm

The cost imposed on society as a whole worldwide for the proliferation of over-leveraged and speculative behavior of the US financial industry in the housing bubble debacle is many times the costs reported in this article. What ever it takes to get stable and equitable behavior out of these gunslingers is warranted. They've bled excessive profits out of the system with careless disregard for analyzing the risk they undertook with other people's money. The entire industry needs to be a lot more green eyeshades and lot less Gordon Gekko.