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Yellen Pushes Back on Volcker Rule Opponents

NEW YORK ( The Deal ) -- Federal Reserve chairwoman Janet Yellen on Tuesday refuted assertions by Republicans that the Volcker Rule - written to prohibit big bank speculative proprietary bets - would limits efforts to manage risk and would hurt the U.S. economy.

"Banks will be able to go on to engage in activities, particularly market making and hedging, that are really vital to a functioning financial system," Yellen told lawmakers at the House Financial Services Committee, in her first hearing before Congress since becoming chief of the central bank Feb. 1.

The Volcker Rule is a key part of reform legislation drafted in response to the 2008 financial crisis and was enacted in 2010. The legislation is also fashioned to force financial institutions to cash out most of their hedge fund and private equity investments in the coming years. The 900+ page rule, named after former Fed chairman Paul Volcker, was adopted by the Fed and four other agencies in December. Volcker first suggested the concept for what eventually became the rule, when he was chairman of President Barack Obama's economic recovery advisory board.

Critics at the hearing, including Rep. Bill Huizenga, R-Mich., brought up concerns raised by bankers that firms and regulators will have a difficult time differentiating between legitimate market-making actions and prohibited speculative transactions. Banks have market-making obligations to provide liquidity to investors particularly in times of stress, as they did during the flash-crash that rattled the markets in 2010. Big banks provide this liquidity by buying, selling and holding securities and anticipating future customer demands. Opponents on the left have raised concerns that the Fed will permit dangerous speculative trades that are masked as permissible hedging of customer positions.

Regulators have indicated that they will be taking a case-by-case approach to identifying what is permitted and what is prohibited and that banks will have more clarity about the trades over time.

Huizenga warned, however, that the Volcker Rule is driving liquidity from the U.S. He urged Yellen to set a finite review period for the regulation, adding that regulators should take some action quickly to respond to the damage he believes the rule is causing.

"How long will we see liquidity leave the U.S. and us lose market share?" asked Huizenga.

Yellen refused to set a deadline for reviewing the Volcker Rule's impact, arguing that "it certainly will take time to see what the effects of the rule are." Under pressure from Republicans, she acknowledged that proprietary trading was not the "main" cause of the 2008 crisis, but she didn't expand on the extent to which it contributed to the meltdown. She added that the Fed will work with other regulators to supervise and make sure banks comply with the rules.