The Fed: Repo-market turmoil raises almost existential question about post-crisis Wall Street rules, former Fed official says
Former Fed Gov. Daniel Tarullo on Thursday said the turmoil in the crucial short-term lending market in September raises a fundamental question for regulators — will the new rules put in place in the wake of the 2008 financial crisis exacerbate an “over-hoarding” of capital during market stress?
In the September crisis, interest rates on short-term “repo” loans spiked to 10% from under 2%, setting off alarm bells on Wall Street and in Washington.
Fed officials were caught off guard when banks like JPMorgan Chase
While these rules counter the problem of banks “under-hoarding” of liquidity during normal times, it may also cause them to “over-hoard” during periods of market stress, Tarullo said.
“If every bank must sit on its pool of readily usable liquidity in anticipation of possible failure, the result could, in periods of stress, be a decidedly suboptimal [outcome] that starves an already strained financial system of needed liquidity,” Tarullo said.
Patricia Mosser, director of the MPA program in economic policy management at Columbia University, said it would be worrisome if Tarullo was right.
If liquidity hoarding would ever occur in a “true period of market stress, it would be a complete disaster,” Mosser said.
The need to provide liquidity would fall on shadow banks, she noted.
Sandra O’Connor at Brookings (paraphrased): the U.S. financial system may have more High Quality Liquid Assets than ever, and yet be less flexible than ever. That’s not necessarily better.
Tarullo and other experts at the discussion disagreed, saying the episode was not hugely troubling and the volatility was a useful episode for regulators.
Short-term funding markets have rarely been volatile since the financial crisis because the Fed was buying assets to keep down long-term interest rates.
Tarullo will be a key voice in the upcoming debate because he was the Fed’s point person on bank regulation from 2009-’17.
He suggested an alternative would be instead to make sure banks have “sustainable funding practices.” But moving away from the mandates that banks hold pool of liquidity will take time, he said.
In the meantime, Tarullo said he agreed with Jamie Dimon, JPMorgan’s CEO, who has argued his bank couldn’t lend out money during the repo market stress because of the myriad of Fed capital requirements. Randal Quarles, who took Tarullo’s place as the Fed’s point person on bank supervision, has also agreed with Dimon.