Being required to sell assets of a certain class will obviously distress the market for the CDOs in question.
The regulators "may be creating artificial holes in these comunity banks that will have to be filled by other types of capital," according to Frank Mayer, a partner in Pepper Hamilton's Financial Services Practice Group in Philadelphia.
According to the Journal, two community banks acted as petitioners in a court complaint filed by the ABA Monday, which may give the ABA legal standing to sue the regulators.
Mayer thinks the complicated issues over Volcker need to be worked out "in the executive branch and Congress," rather than in the courts.
"They could put a moratorium on enforcing the rule. Maybe the FDIC or OCC could work on enforcement pending clarification on whether this type of structure is indeed a covered fund," he says.
Kevin Petrasic, a partner in the Global Banking and Payments Systems practice of Paul Hastings in Washington, also sees the Volcker Rule as a major problem for smaller banks.
"The ultimate irony is that this rule that was touted as going after the big banks is hurting the small banks, not only becsause of the uncertainty but because they have to evaluate their investment portfolios. If it is determined that their [CDOs backed by trust preferred securities] are subject to the Volcker rule, they will be taking a huge capital hit," Petrasic says.
"There are two options for the industry: a legal challenge or going to Capital Hill to get it addressed. But as soon as you open one part of the Volcker Rule for discussion, you're taking a significant risk that everything becomes fair game," Petrasic adds.
And that could mean more unintended consequences for community banks.