Sifma and other lobbying groups say the burden of proving they're not prop trading falls on the firm, which will raise compliance costs and discourage buying and selling for market- making purposes. Some clients agree. Zane Brown, a fixed-income strategist at Lord Abbett & Co. in Jersey City, New Jersey, said his firm, which manages about $100 billion of assets, already has felt the impact of banks being reluctant to make markets in anticipation of the Volcker rule.
"Dealers are less willing to carry inventory," Brown said in a phone interview. "So liquidity has gotten much worse in the last six to nine months. When they don't want to carry inventory, we can't sell big blocks of bonds to them. They want to look for a buyer to match the seller first. That lowers the price because the buyer knows the seller is trying to get out of the position."
Other fund managers say the reluctance is the result of deteriorating market conditions, not fear of pending rules.
"Since the 2008 crisis, the fear of getting stuck with losses has made the banks less willing to buy less liquid bonds," said Sean Simko, who manages $7 billion in bonds at SEI Investments Co. in Oaks, Pennsylvania. "With the European crisis getting worse in the second half of last year, the reluctance has increased."
Bid-Ask Spread
Before the financial crisis, the difference between the market-maker's bid for buying an investment-grade bond such as one issued by International Business Machines Corp. and the offer for selling it would be 2 or 3 basis points, Simko said. Post-crisis, that bid-ask spread has climbed to 20 to 30 basis points, he said. A basis point is 0.01 percentage point.
Some increased trading cost might be payback for the underpricing of risk before the crisis, said Charles Whitehead, a professor of finance law at Cornell University.
"A little friction in the market can be a good thing to prevent a crisis," he said in an interview.
Hedge funds could take over the role of market-making from banks, Whitehead said. Still, while the cost of implementing the Volcker rule might not be as high as the Oliver Wyman study predicted, it could exceed the benefits, he said. That's because by only banning short-term prop trading, the rule doesn't prevent banks from taking oversize risks with their own money on longer-term investments.
Volcker Complaint
"What caused the crisis was banks holding toxic mortgage securities -- long-term assets -- and financing them with short- term money," Whitehead said.
The alleged failure of the Volcker rule to address the real causes of the crisis was one of the criticisms cited in a staff memo sent last week to members of the House Financial Services Committee in advance of today's hearing and obtained by Bloomberg News. The committee's staff also pointed to displeasure by Volcker with the proposed guidelines.