New SEC Commissioner Kara Stein talked Friday at the "SEC Speaks" Conference and commented on short-term funding and money markets last week in a Reuters story "SEC's Stein calls for more reforms to short-term lending market". She said Friday, "Our lessons from the financial crisis are not exclusively addressed by the Dodd-Frank Act. We must also think proactively of ways to mitigate threats to our financial system. During the depths of the financial crisis, the true fragility of our financial system was revealed as financial tidal waves washed over the global economy. I was working in the Senate as the crisis unfolded, and I can assure you that I will forever remember those frightening times in 2008 and 2009."
She explained, "Our government took extraordinary measures to save the world economy, pouring trillions of dollars into the markets and financial firms.... As financial institutions struggled for funding amidst the sharp pullback of the short term lending markets, the Federal Reserve eased the rules, and expanded the ability of firms to tap the discount window. It created several unprecedented programs out of thin air with technical-sounding names, such as the Term Auction Facility, the Primary Dealer Credit Facility, and the Term Securities Lending Facility."
Stein continued, "To help provide liquidity directly to borrowers and investors in key credit markets, the Federal Reserve also created the Commercial Paper Funding Facility, the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility, the Money Market Investor Funding Facility, and the Term Asset-Backed Securities Loan Facility. Some of these programs worked, and others didn't. But collectively, these and other efforts helped stem the tide of the credit crisis. I also note that most of these markets, and those who participate in them, are regulated by the Commission."
She told the audience, "Now, several years removed, some seem determined to forget what happened, arguing that we should ignore the inter-relationships that nearly caused global economic collapse. I cannot forget. I will not ignore the relationships between banks, broker-dealers, funds, and investors. Nor will I forget how those relationships nearly unwound our financial system."
Stein explained, "For example, the short term funding market is a complex ecosystem in which investors, including money market funds, interact with broker-dealers, banks, and non-bank issuers. Behavior by one sector in the market will have repercussions for the rest. For example, if the demand provided by money market funds for short term paper dries up, even if there isn't a so-called "run," what happens? Similarly, if lenders refuse to accept even high-quality, stable-value collateral, to support their short term loans, what happens? We learned that supposedly well-capitalized firms could quickly fall victim to liquidity crises. And we learned that highly leveraged, affiliated broker-dealers can threaten even some of the largest banks."
She added, "Since the crisis, regulators around the world have been working to improve capital, leverage, liquidity, and margin rules. There is a reason why Congress and regulators have been working to tighten the definition of what constitutes "capital" in the years since the crisis. There is a reason why our fellow regulators care deeply about the risks posed by securities lending and the tri-party repo markets. And there is a reason why the Financial Stability Oversight Council (FSOC) has been working with the Commission to address risks posed by money market funds. Our government put trillions of dollars on the line to bail out, directly and indirectly, our entire financial system, and each of these areas played a key role in the crisis."
Finally, Stein commented, "We, at the Commission, are working on rules to prevent runs on money market funds. Those are valuable efforts, but they do not go far enough to address systemic risks. Our regulations shape the role that money market funds play in providing short-term funding for issuers, particularly the largest financial firms. We must consider whether regulations need to be updated. We should consider whether enhanced capital, leverage, liquidity, and margin rules would help mitigate risks at the firms, and in the markets, we regulate."
Last week's Reuters article (from The Chicago Tribune) tells us, "The short-term lending market is in need of reform to improve its transparency, a top U.S. regulator said on Wednesday, saying that the lack of public information on how much financial firms rely on such borrowing could lead to another financial crisis." Stein told Reuters, "We should be doing more to improve large financial firms' disclosures about how reliant they are on short-term funding, and how susceptible they may be to liquidity crises. Improving disclosures about short-term funding will empower the markets to help prevent the next liquidity crisis."
Reuters added, "Stein did not describe how a final money market fund rule should be drafted. However, she said the rule targeting fund run risk is "just one part of the short-term lending market" and should not be all that regulators do in this space. She urged the SEC to work more closely with other regulators on the issue."
Stein said to Reuters, "We need to be thinking about other parts of this market that should be reformed to prevent another financial crisis. The SEC oversees the broker-dealers who are integral to securities lending and the corporate issuers doing the borrowing, so we need to be working with our fellow regulators to address the risks of short-term funding."
