Board of Governors of the Federal Reserve System (“FRB”) Vice Chair Stanley Fischer delivered remarks on the importance of the non-bank financial sector at the Debt and Financial Stability – Regulatory Challenges conference.
Mr. Fischer described how non-bank intermediation in the United States has changed, as well as non-bank financial institutions’ role in the financial crisis. He explained that the growth of the non-bank sector has increased the complexity of the financial system and lengthened intermediation chains. Additionally, according to Mr. Fischer, non-banks “increase the amount of maturity transformation conducted in the financial system without the stability-enhancing backstops offered to banks.”
Mr. Fischer also explained that a variety of reforms have helped address risks in the non-bank financial sector, such as the creation of the Financial Stability Oversight Council (“FSOC”), the SEC’s adoption of new rules for money market mutual funds, and a new rule regarding securitization. He stated that while “there are signs of reduced non-bank financial sector vulnerabilities,” there are areas that require continued work, including:
- short-term wholesale funding markets – Mr. Fischer stated that there are many non-bank financial firms that continue to rely on secured short-term funding to finance their activities, many of which involve longer-term and illiquid assets;
- areas of the non-bank sector that are not subject to prudential supervision, such as the asset management industry; and
- gaining better data coverage on certain areas of the non-bank financial system, such as the hedge fund industry.
Lofchie Comment: Notwithstanding Governor Fischer’s learned and moderate point of view, the underlying suggestion is arguably quite radical: that the federal government, acting either through the Board of Governors or through the FSOC, should have much greater control over the investment and funding decisions made by private investors; i.e., the “asset management industry.” Nor is Mr. Fischer the only member of the Federal Reserve to so indicate that governmental control over private investment decisions should be increased: see, e.g., Governor Tarullo’s speech on Macroprudential Regulation.
It is obvious that Dodd-Frank magnified by many times the power of the government with respect to the financial sector; while one can debate whether that is all to the good, there is certainly no doubt that an increase in governmental power was intended. It is not at all clear to me that Congress intended the type of increase in governmental power suggested by Governors Fischer and Tarullo. What they suggest goes far beyond regulating financial intermediaries; they suggest governmental control of private investment decisions.
As to the suggestion by the FSOC, to which Governor Fischer refers, that asset managers could be “systemically significant” – that seems so outlandish on its face as to not be serious. But there is a more serious issue that has been raised by creation of the FSOC: that the FSOC could determine that asset managers as a group make decisions that are not optimal for the economy as a whole, perhaps because they invest in too similar a manner. (By way of example, here is a key take-away from the report of the Office of Financial Research (“OFR”) on the asset management industry (at page 10): “[Existing] regulation [of asset managers] focuses on helping ensure that managers adhere to their clients’ desired risk-return profiles, but does not always address collective action problems and other broader behavioral issues that can contribute to asset price bubbles or other market cycles.”) One can readily concede to the truth of this OFR/FSOC observation: it is the nature of a free, capitalist economy that individual investors make investment decisions that are not dictated by the government, even if some government agency might determine that some other set of investment decisions, taken as a whole, would be preferable.
Of course, the government has many ways to influence private investment decisions; e.g., by altering tax rates, tax deductions, governmental subsidies, the money supply, borrowings through the Federal Reserve Bank of New York, and so on. There is certainly room for debate as to which measures are appropriate and effective, but moving beyond those “traditional” exercises of government power to the actual dictation of investment decisions and financing decisions made by private parties should not be viewed as ordinary course.