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Federal Reserve Staff Paper Says Volcker Rule Contributed to Market Illiquidity

A staff working paper from the Federal Reserve discussed the implementation of the Volcker Rule and its impact on bond market liquidity, particularly in times of market stress. The Volcker Rule was enacted as part of the Dodd-Frank Act and prohibits banks from making certain speculative investments with their own accounts. The paper concludes that illiquidity of stressed corporate bonds increased after enactment of the Volcker Rule: “Dealers regulated by the Rule have decreased their market-making activities while non-Volcker-affected dealers have stepped in to provide some additional liquidity. …Since Volcker-affected dealers have been the main liquidity providers, the net effect is that bonds are less liquid during times of stress due to the Volcker Rule.”