The Volcker Rule paves way for next financial crisis

In July 2010 United States Congress voted for Wall Street Reform and Consumer Protection Act, which according to some economists decreased danger financial risk. The Dodd-Frank regulations are working but some economists argue that US economy to achieve this goal paid too high price.

This new regulatory regime seems to significantly reduced the stress on banking industry. So far this year, only 6 banks which had $869 million in assets failed, 18 banks with $398 mln in 2014 and 24 banks with $1.1 billion in 2013. This sharp fall in comparison with 2009-2012 when 389 banks failed with over $72 billion in assets.

The effect is stability of financial institutions but stagnation of economic growth is a price.

New regulations obliged financial institutions holding with $50 billion in assets or more (systemically important financial institutions – SIFIs) to increase capital levels, prepare plan detailing how they would be broken up if they fail and participate in annual Fed-conducted stress tests. The other requirements included employment of compliance officers.

The effect is stability of financial institutions but stagnation of economic growth is a price.

“We find that the median reduction in profitability for banks with less than $50 million in assets is 14 basis points if they have to increase staff by one half of a person; the reduction is 45 basis points if they increase staffing by two employees. The former increase in staff leads an additional 6 percent of banks this size to become unprofitable, while the latter increase leads an additional 33 percent to become unprofitable.” – argued analysts from Federal Reserve of Minneapolis.

In a 2014 study, the American Action Forum showed that three requirements in the Dodd-Frank Act, the pay ratio rule, the Conflict Minerals provisions and the Volcker Rule totaled more than $10 billion in costs for financial firms, but none has been shown to be a cause of the crisis.12 For the reasons outlined earlier, these costs are reducing the availability of credit and slowing economic growth for reasons of social justice or the placation of a special interests, not because they were deemed necessary to address the financial crisis

The lack of liquidity in the markets and what this might mean for the world economy dominates today conversations in financial circles.Market veterans say they have never experienced anything like it.

From the other side the Dodd-Frank made for small and medium business access to bank loans more difficult. The bank loans became more expensive and the competition between banks weakened due to the smaller ratio of new banks creation.

Paradoxically the stability of financial institutions may be cause of another financial crisis. Why? The Volcker Rule that forbids banks and their affilietes proprietary trading of debt securities discouraged banks from being active in making markets in debt securities. In the past banks would stand ready to buy or sell these securities. (It is almost impossible to tell the difference between making a market – that is, buying and selling for your own account – and proprietary trading.)In effect banks have begun to reduce their open-market operations (market-making activities) leaving market for all securities with far less liquidity than it had before the Volcker Rule was adopted.

This regulation “substantially reduced the amount of capital and liquidity available to the debt markets. The lack of liquidity has almost certainly increased the buy-sell spreads in the debt markets and the costs of buyers, sellers and investors who trade in fixed income securities. It is now much more difficult to sell a fixed income security and thus much more risky to buy one.” – noticed author in Wall Street Journal.

What is the topic that dominates today conversations in financial circles?

“It isn’t Greece, or the U.S. economy, or China…It is the lack of liquidity in the markets and what this might mean for the world economy—and their businesses. Market veterans say they have never experienced anything like it. (…) The U.S. corporate-bond market has almost doubled to $4.5 trillion since the start of the crisis, yet banks today hold just $50 billion of bonds compared with $300 billion precrisis.”

Former White House Special Counsel on economy Dr Peter J. Wallison emphasized the Obama administration has denied that the Volcker Rule could be a major factor—or indeed any factor—in the decline of market liquidity, but in July 2015, Lael Brainard, Fed governor, admitted that regulation could be playing a role.