Bair Critiques Money Funds, Again
Former FDIC Chair Sheila Bair posted an editorial on Yahoo Finance entitled, "Biden-led regulators need to crack down on nonbank risks — or let them fail." She writes, "There are many important issues requiring President Joe Biden's attention. I regret to say that 12 years after the Great Financial Crisis (GFC), financial instability remains one of them. This instability was laid bare by the market disruptions of last March when once again, the Federal Reserve felt compelled to inject a massive amount of liquidity to calm tumultuous financial markets. And once again, these bailouts rewarded and reinforced irresponsible risk-taking and unstable business models, instead of letting market discipline impose its will. This is not to say that some level of Fed intervention wasn't warranted. But most of the disruptions occurred in segments of the financial system that were known to be fragile -- and had been identified by financial experts and regulators as sources of past instability. These include money market funds, corporate bond ETFs, and hedge funds speculating in U.S. Treasury markets. Notably, these are entities outside of the regulated banking sector which, because of reforms enacted pursuant to the 2010 Dodd-Frank financial reform law, have remained stable." She explains, "[N]ot all nonbank credit providers were sources of instability in March. Money market funds that only invested in federally backed securities performed well. But so-called 'prime funds,' invested in more volatile corporate debt suffered substantial outflows by institutional investors, required liquidity support from the Fed.... Unless we want to tolerate a financial system reliant on Fed bailouts to function, we need to start providing some level of prudential oversight over entities that exhibit these vulnerabilities -- or let them fail.... Some measures to address shadow bank instability do not seem complicated. For instance, why not impose higher margin requirements on U.S. Treasury and derivatives trading to reduce volatility? Similarly, if money market funds want to create expectations among investors of liquidity and the protection of principal, why not require that they only invest in liquid assets where principal is actually protected (i.e. US government-backed securities), or that they hold capital against this implicit guarantee (as does a bank?)" Bair adds, "Government interventions in financial markets may sometimes be necessary, but they have well-known negative side effects. They reward bad behavior and perpetuate instability. They provide clear benefits to Wall Street, with little demonstrated benefits to Main Street. They should be avoided at all costs -- and narrowly tailored when used."
