LET THE UNINTENDED CONSEQUENCES COMMENCE

The Volcker rule works its magic:

[B]anks cannot satisfy the [corporate-debt investors’] needs because they are reducing their own holdings of corporate bonds, partly because of a raft of new regulations proposed in the wake of the financial crisis.

These rules are already altering the way banks behave. While tougher capital standards under Basel III and the pending Volcker rule seek to avoid another meltdown in the banking system, they have had the unintended consequence of sucking liquidity out of the corporate debt market. If banks want to hold riskier assets – such as corporate rather than sovereign debt – they have to go to the greater expense of holding more capital to offset those investments. [Emph. added]

Wonderful. Reduced liquidity in the corporate-debt market of course drives up the cost of credit for issuers, since investors will demand to be compensated for the fact that their holdings no longer freely trade. Fixed-income investors’ returns figure to decline, too, as their trading costs will rise. Volcker rule supporters will argue that the problem is only temporary, since non-banks, not covered by the rule, can step in to pick up the slack in market-making. Maybe. But depending on how those non-banks are funded, they may have to pull back (or worse) the next time there’s a credit disruption-which would be the moment their capacity would be needed the most. I don’t see how that’s a good thing. Remember, too, it’s not prop trading by banks that’s the big risk to the system in the first place. It’s credit that does it. The Volcker rule is truly idiotic. . . .