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At NYU’s ThinkMarkets, Chidem Kurdas gets to the heart of what’s the matter with the Volcker Rule. It will restrict credit and make it more expensive:

Banks are shutting down their proprietary trading. You may believe that is all for the best. But as people warned back when the Volcker rule first came up, there is no clear demarcation between prop trading and market making for clients. Regulators propose intricate sub-rules to make the distinction but it the end it will come down to their judgment, meaning that banks trading for clients will be in danger of violating the no-prop-trading rule. Given the legal risk, they’re reducing their market making.

The consequence is that there are fewer market players to match buyers and sellers. This is a particular problem in the bond market, which is not as deep as the stock market. It is becoming harder to buy or sell bonds. The effects can be wide-reaching. . . .

As the secondary market for bonds becomes less liquid, potential bond investors face additional risk especially with smaller company debt. If they need to sell, what will the market for the bonds be like? . . .

In other words, Dodd-Frank is making it more expensive for smaller businesses to borrow. That can’t be the way to a stronger economy. It certainly is not the way to encourage job creation. [Emph. added.]

Worse, remember that the Volcker Rule will fix nothing. Proprietary trading by banks didn’t cause 2008 meltdown. It was the “common shock” that did it, as Peter Wallison points out. So the bond market will be constricted, with some would-be borrowers likely getting shut out of it altogether, to no benefit whatsoever. Thanks, Paul!