Members of the panel included heads of the Federal Reserve, Securities and Exchange Commission, the Commodity Futures Trading Commission, the Federal Deposit Insurance Corporation and the Comptroller of the Currency. (Ben Kamisar/Medill)

WASHINGTON— Republicans and Democrats on the House Financial Services Committee sparred Wednesday over the effects of a key component of the Wall Street reform act that sets strict limits on commercial banks’ proprietary trading.

The so-called Volcker Rule, which many representatives referred to as overly confusing, was originally a 10-page document that swelled to 298 pages and includes more than 1,000 questions that federal agencies hope will be answered during the public comment period that ends Feb. 13.

The rule, which was required by the banking reform law, mainly prohibits commercial banks with access to federal bailout funds from engaging in proprietary trading, or trades on their own accounts unrelated to customers’ wishes. This type of trading has proved to privatize gains to the firms while pushing the losses to the government, according to experts. These kinds of speculative deals can put the bank at risk of bankruptcy or liquidation and force the federal government to issue bailout funds to banks deemed “too big to fail.” But banks profit largely from the benefits of such trades when they correctly predict the market.

“Banks that have access to the federal safety net [must not be able to use federal funds] to make speculative bets,” Rep. Maxine Waters, D-Calif., said. Opponents fear that a ban on proprietary trading may hurt U.S. banks in the global financial market because they would be forced to compete against foreign banks not subject to such restrictions. With higher liquidity, the foreign banks could offer loans and capital at lower interest rates than other banks, opponents say, potentially squeezing domestic banks out of the market and leading to another credit crunch.

“The Volcker Rule’s goal is to prohibit bank holding companies and their affiliates from engaging in so-called risky activities,” Committee Chairman Spencer Bachus, R-Ala., said. “Unfortunately, the rule’s impact on market liquidity, access to credit, the cost of capital and job creation will unnecessarily stifle the growth of businesses that operate far from Wall Street.”

While the Volcker rule allows a narrow set of activities similar to proprietary trading, Alexander Marx, head of global bond trading for Fidelity Investment, said in his prepared statement that the exemptions were too narrow and the failure to expand them could stifle U.S. economic recovery.

“We believe these factors would combine to have a chilling effect on capital formation and market liquidity,” Marx’s statement read.  ” …In turn, [it] will negatively impact individuals seeking to invest their savings, including shareholders of the funds we manage, and businesses accessing the capital markets to help grow their operations.”

Daniel Tarullo, a member of the board of governors of the Federal Reserve, told the committee that he hoped the hearing will help those charged with regulating the Volcker Rule to understand its intricacies and avoid jeopardizing American markets.

“Our goal at the Federal Reserve is to implement the Volcker Rule in a way that is faithful to the language of the statute… at the least cost to economic growth,” he said. One main hurdle, he explained, was to codify the distinction between proprietary trading and market making, which is widely seen as beneficial to the economy and is allowed under the Volcker Rule.

The heads of the Federal Reserve, Securities and Exchange Commission, the Commodity Futures Trading Commission, the Federal Deposit Insurance Corporation and the Comptroller of the Currency, mainly agreed that their agencies could police banks under the rule as outlined in the financial reform law.  However, they emphasized the importance of the public comment period in allowing them to determine the scope of the restrictions, as well as providing a forum for public input over a rule of this magnitude.

“No question there are a lot of questions,” Tarullo said. “But part of what the questions do is that they reveal to the public how we are thinking… they actually serve a transparency function into giving an insight into how the agency [is thinking].”