AFR Education Fund Statement on Office of Financial Research Staff Working Paper on bond market pricing and the Volcker Rule
WASHINGTON, DC – The Office of Financial Research has released a new staff working paper relevant to the impact of the Volcker Rule on bond market pricing.
This new paper does not contradict previous comprehensive studies finding that liquidity in the corporate bond market has been robust and has shown no signs of deterioration over the period in which the Volcker Rule was implemented. For example, extensive research by the New York Federal Reserve and a study by the Securities and Exchange Commission found that overall corporate bond market liquidity remained strong during the period of Volcker Rule implementation, and in some ways improved over this period. This is consistent with a boom in corporate bond issuance and record low spreads during the years in which regulatory reforms were implemented.
The OFR staff working paper does find evidence that banks affected by the Volcker Rule charge significantly lower markups for newly issued bonds they underwrite (that are exempt from most Volcker Rule restrictions on proprietary trading) than they do for other types of bond trades covered by the Volcker Rule. This is suggestive of some price impact, but the paper does not analyze what, if any, implications this has for the bond market as a whole. The authors themselves state that their data suggests “in aggregate limited impact on all dealers’ corporate bond markups after the Volcker rule’s effective date.” (See page 9 of the paper; emphasis in original)
The paper also finds evidence that non-banks gained a moderate amount of market share from banks in corporate bond trading after the Volcker Rule was implemented. This is an intended and in many ways positive result of the Volcker rule.
Since the OFR staff paper only examines corporate bonds, it also does not contradict the findings in a recent research paper by Federal Reserve economists that Volcker Rule implementation led to a major decline in equity trading risks at covered banks. The authors of that study concluded that the Volcker Rule is an effective financial-stability regulation and protected banks from material aggregate trading losses due to stock market volatility.
We urge those considering the Volcker Rule to examine the now extensive research literature on the effects of the rule and not to inappropriately highlight conclusions advanced by industry lobbyists whose goal is to weaken the rule. AFR has previously analyzed misinterpretations of Volcker Rule studies and has issued a Volcker Rule white paper examining the rule as a whole. Please contact the AFR Education Fund if you would like to discuss these issues further.