An Open Letter to Paul Volcker from a Concerned Citizen
A debrief of the Ripple Effects of the Volcker Rule on the Fragile Global Recovery
01 Apr, 2012 3:29
Dear Mr. Volcker,
I understand that as a result of the proposal of the Volcker Rule, most banks are planning on spinning off their proprietary trading desks into hedge funds. While I recognize the need for limitations on speculation and therefore risky activities that banks undertake, I also would like to point out kindly that the restrictive implementation of such regulation would dampen the efficiency in almost every asset class, both directly and indirectly.
An essential source of funding for American businesses, the core of real GDP growth, is the corporate credit market. Household investors alone hold approximately $3 trillion in corporate debt either directly or through various financial instruments. A restrictive policy that limits the ability of banks to facilitate trading, hold inventory levels sufficient to meet investor demand, and building upon the market’s pricing efficiency, would significantly reduce liquidity across all asset classes. Illiquidity would weigh on prices of investors’ existing holdings in addition to increase transaction costs. Costs to the issuer of securities can also be significant in terms of higher yield and greater discounts on the underlying asset. Overall, increases in the cost of funding for both investors and issuers will hinder the velocity of credit that is required for the recovery and growth of the global economy.
One important implication of the Rule is that it would affect consumer demand, inflation, and economic growth as well as the impact on the price of energy. Scholars have estimated that the Rule could potentially wipe out 200,000 energy-related jobs, while reducing GDP by $34 billion over the next four years. Banks are the middlemen in various hedging activities that energy companies heavily rely on to manage risk. These hedging activities require regular trades on commodity exchanges. Companies also engage in the use of various derivative instruments in the process, in which almost the entirety of the transactions are coordinated by banks. Reduction in the bank`s ability to facilitate these transactions due to the Rule will increase transaction costs, raise the cost of production for these companies and increase energy prices to consumers. If we consider the ripple effect, the Rule could cause companies to reduce their production levels, increase the cost of heating and electricity, and therefore increase the overall cost of business activities in the economy which leads to an increase in expected inflation and unemployment.
As a consumer, I am concerned about the possible repercussions of your rule, dear Mr. Volcker. Having seen, firsthand, the liquidity squeeze during the past few years, I believe that the timing of the proposal and expected implementation of the Rule is far from optimal, and that the US economy may still be too fragile to take on such regulations in its financial sector.
A concerned citizen