In one of the first hearings of the 2012 session, House Republicans Wednesday called for a delay in the implementation or total repeal of a proposed regulation restricting trading by banks, known as the “Volcker Rule.”

“In my opinion, [the Volcker Rule] will be a self-inflicted wound on this country, its economy and its financial entities,” said Rep. Spencer Baucus (R-AL), chairman of the House Financial Service Committee, during a joint subcommittee hearing.

“I’m not sure that it [proprietary trading] contributed to the financial crisis” in 2008, he said. “What we’re hearing from not only companies but [also] consumers is that this rule will threaten [the] United States and its capital markets.”

The Volcker Rule, which was originally proposed by economist and former Federal Reserve Chairman Paul Volcker, prohibits a bank or institution that owns a bank from engaging in proprietary trading that isn’t at the behest of its clients, and from owning or investing in a hedge fund or private equity fund. It also limits the liabilities that the largest banks can hold (see Daily GPI, July 22, 2010).

The Dodd-Frank Wall Street and Consumer Protection Act of 2010 amended the Bank Holding Company Act, thus barring proprietary trading by some financial institutions, including the largest brokerage traders Bear Stearns, Merrill Lynch and Lehman Brothers. But the new law did not restrict the market-making activities of banks or brokerage companies.

“One of the more difficult tasks in implementing the statutory prohibitions is distinguishing between prohibited proprietary trading activities and permissible market-making activities. This distinction is important because of the key role that market makers play in facilitating liquid markets in securities, derivatives and other assets,” said Federal Reserve Governor Daniel Tarullo in testimony before the joint hearing.

Baucus agreed that it would be impossible to distinguish between market making and the prohibited proprietary trading. Regulators said this may be the case when the rule is first implemented, but they noted that companies would have a two-year compliance period. If a company unknowingly stepped over the line in the beginning, it would not be subject to strict enforcement action.

“This type of trading [proprietary] while profitable during good times proved to be tremendously harmful when bets on real estate and other assets started to soar,” said Rep. Maxine Waters of California, the ranking Democrat on the Capital Markets Subcommittee.

The Government Accountability Office reported that the six largest U.S. holding companies lost a combined $15.8 billion from stand-alone proprietary trading desks during the five quarters of the financial crisis, Waters said. “I think the approach that Congress adopted under [the] Volcker provision was very measured and attempted to surgically excise only those elements of trading that pose the greatest risk.”

In the end, “I want to make sure market-making is not impeded and that the rule is not bogged down in complexity,” she said. The Volcker Rule, as it currently stands, is nearly 300 pages, and includes approximately 1,000 questions. Comments are due on Feb. 13.

The Securities and Exchange Commission, the Federal Deposit Insurance Corp., the Federal Reserve Board and the Office of Comptroller of the Currency advanced a proposed Volcker Rule last fall (see Daily GPI, Oct. 13, 2011). The Commodity Futures Trading Commission (CFTC) was the last holdout, waiting until last week to adopt a proposed rule (see Daily GPI, Jan. 12).

CFTC Chairman Gary Gensler said the agency’s proposed Volcker Rule is “consistent” with the joint rule proposed in October. With regard to the Volcker Rule, he noted that the CFTC will be a “supporting member,” while bank regulators will take the lead. Gensler further said that the the agency, as part of its rule, is seeking public comments on whether certain provisions are even applicable to CFTC registrants that are part of a banking entity.

Rep. Carolyn Maloney of New York, the ranking Democrat on the Financial Institutions and Consumer Credit Subcommittee, believes that regulators, all five of whom testified at the joint hearing, “have taken a simple clear goal [of Paul Volcker] and have made it overly complex, in my opinion.” The complexity is particularly evident with respect to “the bright line between proprietary trading and market making.”

Rep. Barney Frank of Massachusetts, the ranking Democrat on the full Financial Service Committee and one of the authors of Dodd-Frank, said he was “one of the 315 members of the House who hasn’t asked you [regulators] to delay” implementation of the Volcker Rule.

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