Today, the Financial Times‘ Robin Wigglesworth released a well-researched article “Learning British Financial Stability Lessons. Seriously!” – which covered CFS reports – https://on.ft.com/3ZZ8Rpc .
CFS will put a finer point on on aspects of the reports in two upcoming events.
Please take a look at this article and our papers, which can be found on CFS’ website- www.CenterforFinancialStability.org.
Category Archives: Emerging Risks
FT: Bair on Protecting Smaller Banks from Investor Nerves
Today, the Financial Times published Sheila Bair’s Opinion piece “Congress must act to protect smaller banks from investor nerves. Measures to shield operational business accounts, introduced during Covid, should be triggered urgently.”
While she does not believe that universal coverage for all accounts is the answer, she does advocate for using the Transaction Account Guarantee (or TAG programme). “To promote banking competition and mitigate concentrations of power, we need to help them protect their core business accounts. Congress needs to reinstate TAG.”
We look forward to any comments you might have.
To view the full article:
https://www.ft.com/content/caae5e89-4f6f-4ec8-94c7-0c15ed4592fa
Sheila Bair is a former chair of the US Federal Deposit Insurance Corporation and a senior fellow and Advisory Board member at the Center for Financial Stability.
US regulators are setting a dangerous precedent on Silicon Valley Bank
Former FDIC Chair and CFS senior fellow Sheila Bair penned “US regulators are setting a dangerous precedent on Silicon Valley Bank” in the Financial Times (FT). The piece covers:
– Systemic risk determination,
– Use of FDIC insurance,
– Fed policy.
To view the piece:
https://www.ft.com/content/b860ebb6-f202-4ec6-a80c-8b1527c949f4
OFR Annual Report Warns of Elevated Risk to Financial Stability
In its 2022 Annual Report to Congress, the Office of Financial Research (“OFR”) warned that threats to U.S. financial stability are elevated compared to previous years because of rising inflation, tight credit conditions and geopolitical uncertainty.
OFR found that U.S. economic growth slowed due to elevated interest rates, a significant increase in commodity prices and lingering supply chain issues from the COVID-19 pandemic. OFR reported that non-financial corporate credit risk is rising, but household credit risk remains low. OFR said that financial stability risk is elevated across the financial system, including (i) macroeconomic risk, (ii) credit risk, (iii) liquidity and funding risk and (iv) contagion risk. OFR also that said (i) high volatility in the digital asset market, (ii) increased frequency and complexity of cybersecurity attacks, and (iii) financial losses due to climate-related financial risk contributed to the increased risk to financial stability.
Additionally, OFR highlighted the launch of two pilot programs:
- the Non-centrally Cleared Bilateral Repo Pilot Project, which OFR said will give regulators more insight into the non-centrally cleared bilateral repo market. OFR is currently considering a rule to establish an ongoing data collection program as to bilateral repo (see previous coverage); and
- the Climate Data and Analytics Hub pilot, which provides regulators with reliable climate data and tools to properly assess climate risks to financial stability.
LOFCHIE COMMENTARY
In the report, OFR tells us, “[a]s a frontier risk, climate-related financial risk—though difficult to model and forecast within the financial system—presents an increasing threat to financial stability. Being able to assess it accurately is vital to mitigating its effects.” Put differently, OFR acknowledges that it cannot measure the risk that climate change poses to financial stability, and it cannot demonstrate that climate change is a financial stability risk, or how risky it is, but OFR pledges to find something there. This makes no sense whatsoever. If the U.S. government is able to demonstrate the risks that arise from climate change in a convincing manner, businesses will adjust to these risks. For now, OFR does not have the data.
Further, much of what OFR paints as “climate change risk” is really very ordinary “weather risk,” such as building houses in areas likely to be flooded, or areas at risk of wildfires. (See footnote 167 of the OFR report and the papers cited therein.) These risks do not arise because the temperature rose a degree; they arise because people are building where perhaps they should not, which undoubtedly creates financial risk. But it is not climate change risk; it’s weather risk. If the OFR would approach the issue of weather more temperately, it would be more likely to produce work of value.
On China’s Financial System and Property Markets: Aliber and Walter
We are delighted to share work presented in recent days by two good friends of the CFS: Robert Z. Aliber and Carl E. Walter.
Carl discussed his forthcoming book The Red Dream: the Chinese Communist Party and the financial deterioration of China. Red Dream analyzes 1) the build-up of leverage throughout the system, 2) how regulators have worked to generate strong performance metrics while sloughing off unwanted assets, 3) the health of the financial system, as well as 4) the present within the context of prior financial stressors in the U.S., Japan and China itself.
Bob offers his latest thoughts on China’s property market, Evergrande, and future economic prospects more broadly. He first discussed these dynamics in the epilogue of the seventh edition of Manias, Panics and Crashes: A History of Financial Crises.
Carl recently served as an independent director of a major Chinese bank. For many years, Carl worked in China, where he last served as JP Morgan’s China COO and CEO of its banking subsidiary. He is now a visiting scholar at the Stanford Shorenstein Asia Pacific Research Center.
Bob is professor emeritus of International Economics and Finance at the University of Chicago. He has written extensively about the prices of currencies, international investment flows, banking issues, the multinational firm, international monetary arrangements, and financial crises.
To view Carl’s slides on China’s financial system:
http://www.centerforfinancialstability.org/research/Walter_China_Feb_2022.pdf
To view Bob’s “The Ponzi Bubble in China’s Property Market is Deflating”:
http://www.centerforfinancialstability.org/research/Aliber_China_031122.pdf
As these topics are complex and challenging, we look forward to any comments you might have.
SEC Proposes Amendments to Money Market Fund Rules
The SEC proposed amendments to the requirements applicable to money market funds pursuant to ICA Rule 2a-7 (“Money Market Funds”) under the Investment Company Act that are generally aimed at preventing a run on money market funds during a time of financial crisis. The amendments were proposed in light of the significant redemptions experienced by money market funds at the start of the COVID-19 pandemic.
Regulatory Changes
The proposed amendments include:
increasing the amount of assets with daily liquidity that a money market fund must hold from 10 percent to 25 percent of its assets; and increasing the amount of assets with weekly liquidity that a money market fund must hold from 30 percent of its assets to 50 percent; funds would be required to institute stress tests to determine their minimum level of desired liquidity; the SEC asks for comment as to what requirements should be imposed on a fund that fails to maintain its required liquidity level;
removing from the existing money market funds rule the authority of funds to impose either gates on redemption or to impose liquidity fees on redeeming investors (the SEC said that such authority was counterproductive encouraging investors to redeem before the gates or fees could be imposed);
requiring institutional prime and institutional tax-exempt money market funds to implement swing pricing, which would permit adjustments to current net asset value per share when the fund has net redemptions (and result in redeeming investors bearing liquidity costs);
modifying certain reporting requirements on Forms N-MFP and N-CR to improve the availability of money market fund information, and making conforming changes to Form N-1A to reflect proposed changes to the regulatory framework for these funds;
adding provisions to address how money market funds with stable net asset values should handle a negative interest rate environment;
adding provisions that specify how funds must calculate weighted average maturity and weighted average life; and
imposing additional reporting requirements on money market funds, including that a fund must file a report when it falls below a specified liquidity threshold.
Comments on the proposal are due within 45 days after its publication in the Federal Register.
Commissioner Statements
SEC Chair Gary Gensler supported the proposal, saying the reforms will help maintain “fair, orderly, and efficient markets.” SEC Commissioner Allison Herren Lee called the proposal a “necessary continuation of our focus on addressing weaknesses of these funds.” She added that, with respect to the public comment period, she would like to better understand the “foreseeable impacts of swing pricing” and how it might impact investor choice. SEC Commissioner Caroline A. Crenshaw stated that both the SEC and investors would be better positioned to “monitor funds’ activities and evaluate the impact of market stress on those funds.”
SEC Commissioner Hester M. Peirce opposed the proposal, saying that, as in the existing rule, there is “too much regulatory prescription and too little room for experimentation by funds.” Ms. Peirce said the proposal could “undermine the objective of making money market funds more resilient” and would “continue the trend of driving more money into government funds.” Ms. Peirce said, such an outcome would leave investors, issuers and markets worse off. Ms. Peirce was supportive of the reform to eliminate the connection between liquidity thresholds and fees and gates.
SEC Commissioner Elad L. Roisman supported some elements of the proposal, including the effort to explore several measures that could reduce run risk for money market funds. However, he dissented and expressed “strong reservations” about the requirement that a “uniform approach to charge fees to redeeming investors” would be applied to all institutional non-government money market funds (emphasis in original). Further, he found the timing of the comment period to be a “major shortcoming,” saying that he did not have confidence that market participants will be able to provide meaningful feedback over a comment period that aligns with several holidays and five other proposed rulemakings.
LOFCHIE COMMENTARY
There may be no area in securities law that is so conceptually difficult to create sound regulation as with respect to money market funds. The central question is: how does one create a fund that maintains a fixed share value of $1, notwithstanding fluctuation in the value of the fund’s asset, and yet avoid having investors redeem when they believe that the true value of the fund is less than $1? So far, mission not accomplished.
Given the difficulty of the problem, Commissioner Peirce’s suggestion that the SEC should be less prescriptive and let different funds approach the problem differently makes sense. After all, as the SEC concedes, the regulatory imposition of gates did not work. Perhaps the SEC would do better to let the market experiment with solutions.
IMF Senior Executives Warn of Financial Stability Risks Posed by “Crypto Boom”
In an International Monetary Fund (“IMF”) blog post, IMF senior executives warned of the risks to financial stability from “cryptoization.”
The executives reported that the value of the crypto asset market increased tenfold from early 2020 to September 2021, even though many of the industry’s intermediary entities (e.g., miners and exchanges) lack “strong operational, governance, and risk practices.” They noted the substantial disruptions experienced by crypto exchanges during times of market turmoil, as well as a number of “high-profile” hacking incidents that resulted in stolen customer funds. While such incidents have not significantly affected financial stability, they argued, the crypto industry’s growth poses significant consumer protection risks.
In addition, the executives noted the money laundering, tax evasion and terrorist financing risks arising from the data gaps associated with the “(pseudo) anonymity” of crypto products. They stated that international regulatory collaboration is critical to crypto market regulation because the majority of crypto exchange transactions take place “through entities that operate primarily in offshore financial centers.” They also expressed concern regarding the risks to implementing monetary policy effectively that may result from the widespread use of cryptocurrencies.
To address issues arising from rapid crypto industry developments, the executives recommended that regulators (i) promptly take action to reduce data gaps, (ii) improve cross-border collaboration to reduce the risk of “regulatory arbitrage” and maximize supervision and enforcement efforts, (iii) implement current international standards that are applicable to crypto assets, including with respect to securities regulation, (iv) assess the benefits of adopting a central bank digital currency and (v) prioritize making cross-border payments more economical, efficient, transparent and widely available through the G20 Cross-Border Payments Roadmap.
LOFCHIE COMMENTARY
For all of the concerns that the U.S. and global regulators have expressed regarding digital assets, there has been disappointingly little focus on distinguishing among the different types of digital assets. A “trust” currency such as Bitcoin raises very different issues from a stablecoin that is fully supported by U.S. dollars in a U.S. bank (assuming, of course, that the dollars are there). These assets are different from digital assets that represent ownership of a company and likewise different from utility tokens. The resort to proclaiming that all of these assets should be regulated as securities has the benefit of simplicity, but it is not correct (at least under U.S. law), and it will make impossible a good number of the legal uses for which digital assets are well suited.
Beers on the U.S. Debt Fight
Today, Barron’s published an op-ed by CFS senior fellow David Beers titled “Democracy is at Stake in the U.S. Debt Fight.”
David discusses the ongoing struggle with deficits and the debt ceiling within the context of Standard & Poor’s (S&P) decision to become the first major credit rating firm to downgrade U.S. debt. At the time, David led S&P’s global team of analysts responsible for sovereign and international public finance credit ratings and research. He later worked on sovereign debt, IMF, China, and Euro Area policy issues for the Bank of England.
As noted in the piece, the opinions are the author’s alone.
Many points are worth further exploration, yet some may be viewed as political. CFS focuses on analytics. CFS is nonpartisan. Hence, we leave the politics for you to sort through.
The op-ed is excellent. It clearly illustrates drivers behind the deterioration in sovereign credit quality in the U.S. as well as other sovereigns around the world. In fact, going forward, economic management with a keen eye to these drivers can reverse the slide in credit quality.
To view the full article:
https://www.barrons.com/articles/us-debt-downgrade-51633382585?tesla=y
We look forward to any comments you might have.
Robinhood and GameStop: Essential issues and next steps for regulators and investors
The hullabaloo surrounding the run up in the price of GameStop (GME) and the activities of Robinhood have generated front page news, calls for action, and allegations of wrongdoing.
However, lost in the headlines and struggles between good and bad or big and little is the issue of greatest concern to all – financial stability.
A group of Center for Financial Stability (CFS) experts
1) examine essential issues as well as
2) propose next steps.
As these are complex and multipronged challenges, we look forward to any comments you might have.
To view the full article:
www.CenterforFinancialStability.org/research/GME_Robinhood_020421.pdf
OFAC Imposes Additional Venezuelan Sanctions
The U.S. Treasury (“Treasury”) Department Office of Foreign Assets Control (“OFAC”) designated five officials affiliated with “illegitimate former” Venezuelan President Nicolas Maduro, pursuant to Executive Order 13692. According to OFAC, these five individuals “continue to repress democracy and democratic actors in Venezuela and engage in significant corruption and fraud against the people of Venezuela.” The individuals include Manuel Salvador Quevedo Fernandez, the “illegitimate President” of Venezuela’s state-owned oil company, Petróleos de Venezuela, S.A.
Treasury stated that it may continue to sanction officials “who have helped the illegitimate Maduro regime repress the Venezuelan people.” As a result of OFAC’s action, all property and interests in property of the designated individuals subject to U.S. jurisdiction are now blocked, and U.S. persons generally are prohibited from engaging in any dealings with them.