AEI Fellow Wallison: Volcker Rule 'Fatally Flawed' and Dangerous

Thursday, 12 Apr 2012 12:12 PM

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American Enterprise Institute fellow Peter Wallison says the Volcker Rule is dangerous and "fatally flawed" because prohibiting banks' bond trading will seriously weaken them and the markets they supply with liquidity.

The financial landscape has changed dramatically since former Federal Reserve chairman Paul Volcker left office in 1987, notes Wallison. Bank lending has declined as a factor in corporate finance, and banks have assumed a major role in far larger and more efficient capital markets.

"Banks are market makers for all kinds of debt securities, and they stand ready in that capacity to buy or sell bonds and other fixed-income obligations at the market price," Wallison writes in The Wall Street Journal.

"If they did not perform this function, individuals, corporations, pension funds and others would not be able to liquidate their assets when they need cash or want to change the composition of their holdings," Wallison writes.

"Yet, in making markets, a bank is clearly trading for its own account."

Part of the Dodd-Frank Wall Street Reform and Consumer Protection Act, the Volcker regulation is almost 300 pages long and contains over 1,000 separate questions for banks and their associates.

“That's not because the regulators delight in abusing the regulated, but because the regulators are grappling with an impossible problem — how to prohibit proprietary bond trading while preserving bank activities that are vital to the health of the capital markets,” Wallison explains, calling the rule “fatally flawed.”

Although Dodd-Frank was intended to prevent future financial crises, no one has yet been able to point to bank proprietary trading as a factor in weakening the banks before the 2008 financial panic, says Wallison.

“The fundamental question is whether we want banks to act as market intermediaries or not. If a case can be made that this is somehow dangerous or will lead to another financial crisis, then let's have someone make it,” he says.

“If the case can't be made — and it hasn't yet been made — then the Volcker Rule should be repealed.”

Bloomberg reports that Fed Chair Ben Bernanke said, “The Volcker Rule raises a lot of complexities, including some international differences. We have heard a number of concerns made” from regulators outside the U.S. that liquidity in foreign government securities could be impaired.

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