Cautions against Macroprudential Regulation

Mercatus Scholar and former Congressional and SEC staff attorney Hester Peirce posted a commentary titled “No, Mr. Tarullo, We’re Not All Macroprudentialists Now.” The commentary examines the effects of a macroprudential approach to financial regulation, particularly in the asset management industry. ¬†According to Ms. Peirce, a macroprudential approach, which would pinpoint the financial system as a whole and not just the well being of individual firms, “could undermine financial stability.” In particular, she explained, adding a macroprudential regulatory layer to asset management would create new risks by narrowing differences in the ways that assets are managed.

Ms. Peirce stated that using tools such as stress tests and liquidity requirements would “corral asset managers into similar strategies, assets, and risk management techniques.” Additionally, she warned that bank regulators will play an “increasingly central role” in regulating asset managers, causing the differences that distinguish the banking industry from the asset management industry to begin to disappear.

Ms. Peirce recommended that regulators emphasize “microprudential responsibility” over macroprudential regulation, since the need for asset managers to plan for bad events cannot be “outsourced to government regulators.”

Lofchie Comment: Governor Tarullo’s belief (see key quote below) that the government should protect the financial system by regulating the investment purchase and sale decisions made by individual investors, funds and advisers is worrisome. Ms. Peirce’s argument that any such regulation would be ineffective is less significant than the fact that allowing the government to regulate investment decisions is fundamentally inconsistent with the continued existence of a “private” market. If the government can dictate, for example, how much “private” investment in the aggregate is to be put into housing, energy or technology, then it follows that the government also must have the authority to allocate investment opportunities (otherwise, how could the government’s decisions about aggregate investments be enforced?). When it is given that much power, the government becomes everyone’s investment “adviser” and failing to take its investment “advice” becomes a violation of law.


Key Quotation: Here is the paragraph from Governor Tarullo’s speech in which he asserts that the government should have the authority to prevent investors from divesting themselves of assets (i.e., from selling), lest they encourage others to do the same:

“Asset management activities have commanded considerable attention lately, both internationally at the FSB and domestically at the Financial Stability Oversight Council (FSOC). The asset management industry has grown rapidly since the financial crisis, both in terms of the dollar amount of assets under management and in the concentration of assets managed by the largest firms. These trends may well continue as stricter prudential regulation makes investment in certain forms of assets more costly for banks. To the extent that asset management vehicles hold relatively less liquid assets but provide investors the right to redeem their interests on short notice, there is a risk that in periods of stress, investor redemptions could exhaust available liquidity. Under some circumstances, a fund might respond by rapidly selling assets, with resulting contagion effects on other holders of similar assets and, to the degree they had not already been subject to redemption pressures, other asset management vehicles holding those assets. The use of leverage by investment funds, including through derivatives transactions, could create interconnectedness risks between funds and key market intermediaries and amplify the risk of such fire sales.”