New York Fed. President Dudley Discusses Short-Term Wholesale Funding Issues

Federal Reserve Bank of New York President William C. Dudley delivered opening remarks at the Workshop on the Risks of Wholesale Funding. The Workshop was held in New York on August 13, 2014 and was sponsored by the Federal Reserve Bank of Boston and the Federal Reserve Bank of New York.

Mr. Dudley’s remarks focused on the role of wholesale financing (such as money-market mutual funds and tri-party repo) in the financial crisis. As Mr. Dudley explained, in the years preceding the crisis, market participants came to rely on short-term funding to finance longer-term assets, creating maturity mismatches. This type of financing, especially when used to finance illiquid and opaque assets such as mortgage-backed securities, is inherently prone to bank runs and self-fulfilling prophecies of financial weakness.

But while these risks have long been recognized in the banking sector, where recurring bank runs were eventually eliminated with a combination of deposit insurance, the Federal Reserve’s role as “lender of last resort” and prudential regulation, they were not as effectively perceived or addressed in the “shadow banking” system. The financial crisis began when losses in the mortgage market forced market participants to sell assets, pushing prices down and spurring lenders to demand more margin. This created a vicious circle that made the weaknesses of the shadow banking system more apparent as the liquidity crisis spread with startling speed and severity.

The Federal Reserve (“Fed”) and the U.S. Treasury Department (“Treasury”) stepped in with a number of programs designed to inject liquidity into the system and stabilize the markets. The Fed intervened in the tri-party repo markets, money-market mutual funds, and even directly in the market for commercial paper, among other places. Although these stopgap measures were effective at that time, Mr. Dudley argued, they were not a sufficient response to the weaknesses of the shadow banking system, especially since Dodd-Frank imposed more stringent conditions on the Fed’s authority to engage in emergency lending in the future. The Workshop on the Risks of Wholesale Funding was organized as part of the Fed’s ongoing efforts to increase the stability of the U.S. financial system. Below is a link to a PDF of the agenda for the workshop that, in turn, contains links to several papers that were presented. One of the topics discussed was whether the Bankruptcy Code’s safe harbor for repurchase transactions should be reconsidered and potentially limited to liquid securities (and not, for instance, to mortgage-backed securities).

See: President and CEO of the New York Federal Reserve Bank William C. Dudley’s Remarks at the Workshop on the Risks of Wholesale Funding.
Related news: The President of the Federal Reserve Bank of Boston’s Remarks on Broker-Dealer Capital (August 13, 2014).