Speevr | Finance

Where is the Fed Vice Chair for Supervision?

Randal Quarles, the first Trump appointment to the Federal Reserve’s Board of Governors, finished his four-year term as the Vice Chair for Supervision on October 13, 2021. To replace him, President Biden has nominated no one. The Fed replaced him with no one. For now, the Fed’s vital supervisory and regulatory priorities will be managed by the Fed’s Board of Governors, through their committee structure.

There is much to lament with this state of affairs. Quarles was the first to hold the position: it was created in 2010 in the Dodd-Frank Act to encourage the Fed to focus more completely on the vital work of bank regulation and supervision, areas that many feared had become neglected during the Greenspan years. Even though the position was created under a signature law of the Obama administration, that administration did not prioritize the formal appointment, relying instead on Fed Governor Tarullo to manage the portfolio, just as former Fed Governors had done. Today, for reasons known only to the administration itself, if known at all, the Biden administration has been plagued by delays in filling Fed and other financial regulatory vacancies. Even though the Vice Chair’s term is fixed by statute at four years, we still have no insight into the people the administration is even considering to succeed Quarles, as the administration has not even announced an intent to nominate anyone to any position at the Fed.
Quarles, a Republican, pursued a bank regulatory and supervisory agenda with expertise and a clear vision. He is no favorite of some Democrats, who do not endorse his vision, have little use for his expertise, and have been eager to see him depart the scene. Whether the Democrats would prefer it otherwise or not, Quarles is not going anywhere for now. He remains a Fed Governor, with the same important responsibilities over regulatory, supervisory, and monetary policy as his colleagues on the Board. That term is fixed for fourteen years and will not expire until 2032.
Here is the good news. Despite the mishandling of these vacancies from the Biden administration, the Fed’s decision not to reassign these priorities to another Governor is exactly the right thing to do. Its other alternatives are not attractive. It could have given now-Governor Quarles the responsibilities despite the expired term, but his ability to operate without the benefit of his statutory status would be significantly curtailed. The other option is hardly better: the Fed could have given these responsibilities to a candidate more in line with Democratic priorities—Fed Governor Lael Brainard, an expert on virtually every regulatory and supervisory question before the Fed, would fit this bill nicely. But Governor Brainard herself is a candidate to succeed Fed Chair Jay Powell, whose term as Chairman expires in January, and any move to reassign her portfolio could look like meddling in the Fed Chair sweepstakes that is still ongoing.
And so, the Vice Chair for Supervision—that unique creature of governance created by Congress just a decade ago—remains vacant, creating the possibility that financial regulation and supervision will not take their place at the forefront of the Fed’s policymaking. What’s more, the replacement of the Vice Chair position with a committee will devolve more authority to the Fed’s staff to handle this highly political and politicized portfolio.
So why is this good news? Because public oversight of the Federal Reserve System is primarily a product of public governance. We need, as a public, to have rigorous debates about who we want our central bankers to be. One such debate is underway as the Biden administration continues to consider the president’s appointment of the Fed Chair. Those who support Jay Powell, the incumbent, praise his leadership during the 2020 pandemic crisis and his management of a major shift in monetary policy regime. His detractors argue that his regulatory priorities are insufficiently aligned with those of the president, especially around bank regulation, financial stability, and climate change. While the tone of this debate can veer toward hyperbole—an American political tradition as old as the Republic—this is what politics looks like. We should welcome it.

Big techs in finance: on the new nexus between data privacy and competition

by Frederic Boissay, Torsten Ehlers, Leonardo Gambacorta and Hyun Song ShinBig techs’ entry in finance builds on their established digital platforms in e-commerce, search and social media, and holds the prospect of efficiency gains and greater financial inclusion.

Policymakers must enable consumer data rights and protections in financial services

After years of inactivity, momentum is gathering for policy action on issues related to consumer financial data in the United States. In July, the president issued an executive order encouraging the Consumer Financial Protection Bureau (CFPB) to enable data portability in financial services. The CFPB issued an advance notice of proposed rulemaking last year and expects to commence a rulemaking process in spring 2022. Congress has shown interest in the subject as well, most recently by holding a Task Force on Financial Technology hearing on consumers’ right to access financial data.

Such momentum is long overdue. Data portability in financial services has the potential to help consumers in their choice of financial service provider and enable innovation by new entrants seeking to offer a better deal or a novel product or service. While data portability is necessary to realize a more competitive and innovative financial services sector, other consumer data rights and protections are also needed. Our research indicates that consumers are demanding greater control than the current legal and regulatory framework governing financial data provides. To be responsive to these important interests, both regulatory and legislative action is needed to ensure that consumers have appropriate data rights and protections.
Background
In the wake of the global financial crisis and the ensuing public outrage over the behavior of “too big to fail” banks, policymakers in the early 2010s found themselves looking for ways to promote competition in financial services. While many debated the merits of breaking up large banks or a new Glass-Steagall Act to separate retail and investment banking, others looked for ways to promote competition from the ground up. Around the world, policymakers began to contemplate data portability measures as a way to loosen banks’ hold on dissatisfied customers.1
In the United States, this responsibility fell to the CFPB. Under Section 1033 of the Dodd Frank Wall Street Reform and Consumer Protection Act of 2010, the CFPB was empowered to prescribe rules to enable data portability in financial services.2 However, with numerous other priorities on the CFPB’s to-do list, rulemaking on Section 1033 never took place. Instead, the CFPB issued non-binding principles for data sharing and closely monitored developments in the market.
Meanwhile, consumer demand for data portability accelerated, driven by the burgeoning fintech revolution. To meet this demand, “data aggregation” companies such as Plaid began to connect consumers’ favorite fintech apps to their bank accounts. Data aggregators often used online banking login credentials shared by consumers to gain entry to consumer accounts and “screen-scrape” data available to consumers via online banking portals. Though this practice is still in use, aggregators have more recently begun to enter into contracts with banks, credit unions, core technology providers, and others to lessen dependence on credential-sharing and screen-scraping in favor of the use of tokenized account access and application program interfaces (APIs).
The financial data sharing ecosystem largely built on this technological framework has given rise to a vibrant fintech market, including many innovative companies who use consumer financial data to design products and services that help consumers improve their financial health. Today, fintechs offer products that use consumers’ financial data to help them avoid costly overdraft fees when their balances dwindle, build emergency savings when their balances grow, and optimize their bill payments to ensure that bills are paid on time without creating a liquidity shortfall. Other fintechs use cashflow data for underwriting purposes, a practice that shows evidence of increasing access to credit among those without a credit history or a credit score and those whose credit scores understate their creditworthiness.3 Still other fintechs use financial data to enable their customers to send money to friends and family within and between countries. These services are widely used, and their popularity has only increased as more and more banking activity moved online during the COVID-19 crisis.

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In early 2021, the Financial Health Network conducted a nationally representative survey to explore consumers’ interactions with, and attitudes towards, the financial data ecosystem. According to our research, more than two thirds of banked consumers are fintech users, having linked financial apps to their checking account. In contrast with banks and credit unions,4 young people and people of color are particularly likely to use fintech apps, with apps used to send money to friends and family being the most common type of fintech app and the type of fintech app used most frequently.

The need for data portability
The lack of a comprehensive legal framework designed to govern the rights and duties of the various players in this ecosystem creates risks for individual consumers, financial institutions, and the functioning of the financial data ecosystem as a whole. Last year, the Financial Health Network partnered with FinRegLab, Flourish Ventures, and the Mitchell Sandler law firm to produce a comprehensive analysis of the legal and regulatory landscape governing consumer financial data. This analysis uncovered numerous open interpretive and policy questions related to Section 1033 as well as older statutes covering a set of interlocking issues including privacy and security under the Gramm-Leach-Bliley Act, accuracy and privacy under the Fair Credit Reporting Act, fairness under the Equal Credit Opportunity Act, and liability under the Electronic Funds Transfer Act.
Unless regulators take action, these open questions will continue to fester and have the potential to impede data portability. Already there are reports of some financial institutions restricting access to consumer data.5 Such restrictions can serve to entrench incumbent institutions and limit competition to the detriment of consumers. These restrictions also are out of step with consumer preferences. According to our research, 62 percent of consumers are in favor of data portability, believing that their bank or credit union should be required to share their personal data with another company (such as a fintech provider) if the consumer directs it to do so.
Importantly, this majority holds across demographic groups, including age, gender, education, race/ethnicity, and household income. Support for data portability in financial services is also bipartisan, with majorities of self-identified Democrats, Republicans, and Independents in favor of it.

Support for data portability holds regardless of the type of institution that serves as a consumer’s primary bank or credit union. This underscores the importance of ensuring that customers of small financial institutions with more limited technological resources have access to secure, affordable solutions to enable data portability.

These results confirm a broad consensus in favor of data portability that has been increasingly apparent for some time. Indeed, at the CFPB’s Symposium on Consumer Access to Financial Records in early 2020, few participants disputed that data portability is a right that should be available to consumers and that rulemaking on Section 1033 should guarantee.6 What they did not agree on was what other rights and protections should be guaranteed and how best to do so.
The data minimization principle
Among the issues dividing large banks, small banks, fintechs, data aggregators, and other market participants at the CFPB’s 2020 Symposium was the question of the scope. What kind of data fields should be able to be shared under Section 1033, and who should decide what kind of data are appropriate for what use case?
In the absence of regulatory guidance, the scope of data available to be shared at a consumer’s direction today varies greatly depending on where a consumer banks. Practically, this means that while some consumers currently enjoy a high degree of data portability, others have a much more limited ability to consistently share their data. As a result, consumers are unlikely to understand the scope of the data they share unless they carefully read complex legal disclosures.
The Financial Health Network asked fintech app users who had connected their fintech app to their checking account how much of their checking account data their fintech app is capable of accessing. 41 percent reported believing it could only access the data it needed, 25 percent reported believing it could access all of their checking account data, and the remaining third of respondents reported that they did not know.
When asked about how much of their checking account data fintech apps should be able to access, 87 percent reported believing that their fintech app should only be able to access the data it needs. Only 11 percent reported believing it should be able to access all the data in their checking account. In other words, consumers know what rules they want, but they are not sure if the current system is aligned with their preferences.
As with data portability, this preference for data minimization holds across demographic groups, including age, gender, education, race/ethnicity, household income, and political party affiliation. Unlike data portability, the preference for data minimization is overwhelming, with support usually in the high 80s to low 90s, with at least 75 percent of each demographic group in favor.

This indicates that while consumers desire the right to data portability, they have a strong preference for discretion as they share their data and do not wish to share any data beyond what is required for a given use case. Some data holding financial institutions (such as banks) have also emphasized this data minimization principle. However, those entities have their own competitive incentives to limit data flows and would not be impartial arbiters of what data are needed for a given use case.
With this market dynamic in mind, the CFPB should use its authority under Section 1033 to determine what data must be accessible, how often they must be made available, how long those data can be accessed for, and to whom they may be made available. If the CFPB does not feel it has the authority to impose data minimization limitations on data aggregators and recipients without impeding data portability, further legislative action may be needed to empower the Bureau to ensure that those entities are only accessing the data they need for a given use case, and are only storing that data for the minimum amount of time necessary. Congress will find strong support for this principle across the political and socio-economic spectrums.
Protecting consumers’ privacy
Consumers’ preference for discretion is not limited to the data they choose to share with fintech apps. Indeed, our research indicates that consumers are equally sensitive to financial or personal data about them being shared without their affirmative consent, no matter what institution is doing the sharing. Just as consumers do not want big tech companies sharing data about their browsing patterns without consent, consumers likewise do not want their bank or fintech app sharing financial data about them without their consent. Our survey shows consumers seem to view these forms of data sharing in much the same way, despite other research indicating that consumers have differing levels of trust for these institutions more broadly.7
Almost 90 percent of consumers (consistent among all demographic groups) expressed a preference for data sharing by their primary bank or credit union to be bound by an opt-in standard rather than an opt-out standard.

This strong preference for an opt-in standard stands in sharp contrast with current legal requirements which cannot be changed without legislative action. At present, consumers who do not want their data to be shared must opt-out, and even their ability to do that is limited. Banks are still permitted under the Gramm-Leach-Bliley Act to share consumer data with non-affiliated third parties if the information sharing is subject to one of the numerous exceptions under the law, regardless of whether a consumer might prefer them not to share.8 In other words, the current law places the burden of protecting privacy on consumers, who are expected to carefully parse complex legal disclosures provided by their financial institution and affirmatively opt-out of any optional data sharing. According to our research, only about 1 in 4 consumers reports having done this. As low as that is, it may under-state how rare it is for consumers to opt-out of data sharing. The plurality of banks interviewed in a 2020 study by the Government Accountability Office reported opt-out rates less than 5 percent.
In order to ensure that privacy protections are reflective of consumers’ preferences, we believe that legislative change is needed. The United States is past due for comprehensive data privacy legislation that not only addresses open issues in financial services but also ensures that consumers are afforded strong and consistent data rights and protections when they interact with tech platforms, healthcare providers, educational institutions, and others. However, if such a comprehensive effort remains beyond the reach of Congress, lawmakers should nevertheless build on the bipartisan consensus among consumers and past interest from both Republicans and Democrats in updating consumers’ data rights and protections in financial services. At the very least, data sharing by financial institutions should be bound by an opt-in standard.
Conclusion
As the financial data ecosystem evolves, regulatory and legislative action to ensure that consumers have strong data rights and protections is increasingly urgent. With momentum for action building and consumers having an unusual level of agreement on the need for data portability, data minimization, and data privacy, policymakers should proceed with the clear goal of ensuring that consumers are the primary beneficiary of the use of their financial data.

Inter-agency coordination bodies and the speed of prudential policy responses to the Covid-19 pandemic

by Michael Brei and Blaise GadaneczThis paper investigates whether the presence of inter-agency coordination bodies for financial stability (IABs) has been associated with faster prudential policy responses to the Covid-19 pandemic.

Indebted Demand

by Atif Mian, Ludwig Straub and Amir SufiThis paper explains the concomitant rise in debt and fall in interest rates by the liberalisation of the financial sector and income inequality.

Joined at the hip: monetary and fiscal policy in a liquidity-dependent world

by Guillermo Calvo and Andrés VelascoWe study the effects of monetary and fiscal policies when both money and government bonds provide liquidity services.

The Treasury market in spring 2020 and the response of the Federal Reserve

by Annette Vissing-JørgensenThe paper shows that Treasury yields did not spike due to a loss of confidence in Treasury fundamentals.

Stability and inclusivity of stablecoins: A conversation with Circle CEO Jeremy Allaire

While cryptocurrency has been around for over a decade, it has only gained mainstream popularity recently. Crypto backers see the technology as the way of the future, but its instability leaves others skeptical. As a less volatile alternative to traditional cryptocurrencies, asset-backed stablecoins have joined the market. But as with all new technology, important questions must be resolved before stablecoins could become a more widely accepted part of our financial system.
In this fireside chat with Circle co-founder, chairman, and CEO Jeremy Allaire, we will discuss the rise of stablecoins, the state of regulation of stablecoins, and the potential for greater inclusion through new financial technology (fintech). The dialogue will cut through much of the hype of cryptocurrency – stablecoins in particular – and dive into the two important and distinct issues surrounding stablecoins: financial stability and inclusion.
This event will be part of the Brookings Center on Regulation and Markets’ Series on Financial Markets and Regulation, which looks at financial institutions and markets broadly and explores how regulatory policy affects consumers, businesses, investors, fintech, financial stability, and economic growth.
Viewers can submit questions for speakers by emailing events@brookings.edu or via Twitter using #Stablecoin.

The US needs urgently to raise its macropru game

Donald Kohn

Robert V. Roosa Chair in International Economics

Senior Fellow – Economic Studies

Implementing robust macroprudential policy—addressing threats to financial stability beyond those that were the focus of safety and soundness on an institution-by-institution basis or of investor protection market-by-market—was a constructive outcome of the legislative and policy response to the global financial crisis of 2008-09.
In the U.S., the Dodd-Frank Act of 2010 strengthened the hand of the Federal Reserve as it addressed the systemic risks in banks and bank holding companies, including those emanating from institutions that were “too big” or “too systemic” to fail. It also created two new institutions to look across the fragmented regulatory landscape to drive macroprudential policy addressing risks outside of banks: the Financial Stability Oversight Council (FSOC), which is chaired by the secretary of the Treasury and includes the heads of federal regulatory bodies, is charged with identifying and responding to risks to the financial stability of the United States, and the Office of Financial Research (OFR), which was created to support the work of FSOC through research and data gathering. FSOC’s powers are limited—it can designate systemically important institutions, and it can make recommendations to constituent regulators—but even those authorities have been infrequently used. The structures set up by Dodd-Frank have not led to consistent and effective macroprudential policies in the U.S.
The Biden administration, under the leadership of Janet Yellen at Treasury, intends to drive more active macropru policies, but at this still early stage of the administration, results are not yet evident. It is urgent they get on with the job. First, the “dash for cash” of March 2020 as the pandemic shutdown set in revealed a number of weaknesses in market-driven financial intermediation that required unprecedented and massive central bank intervention to prevent a total breakdown of the financial system that would have made an already dire economic situation much worse. We had hints of those weaknesses before the pandemic, but they became considerably more visible under stress. Moreover, the actions of the Federal Reserve and other central banks to counter their effects raise the possibility that private risk taking will be distorted by the expectation of future interventions in stress situations. The authorities need to move while memories are fresh and political support for corrective steps is at its highest.
The second reason for urgency is the current economic and financial situation. If the economic and financial situation evolves as seems to be expected in financial markets, credit will flow, and financial markets will continue to serve the needs of the economy. But the current situation is replete with fat tails—unusually large risks of the unexpected which, if they come to pass, could result in the financial system amplifying shocks, putting the economy at risk. At a recent FOMC meeting, the Board of Governors staff characterized financial vulnerabilities as “notable,” reflecting some asset valuations, leverage in corners of the financial system, and persistent structural issues.[1] Moreover, these vulnerabilities have arisen in the context of truly unprecedented circumstances, making it difficult, if not impossible, for policymakers or market participants to predict the future with confidence. There’s the virus, of course, and the public and private response to its evolution. In addition, fiscal policies are raising Federal debt-to-income to record peacetime levels and a new monetary policy framework has yet to play out in practice. Meanwhile, inflation has spiked to the highest levels in many years. Yet market participants appear to have priced in very low interest rates for a very long time even as the economy recovers and, judging from risk spreads and equity prices, are quite confident that higher debt levels can be serviced and sustained—even though a disproportionate increase in private debt has been among lower-rated business borrowers.[2]
Well-functioning U.S. financial markets are essential for well-functioning global finance. We saw all too clearly in 2008 how disruptions in U.S. markets can trigger a global financial meltdown and recession. Building resilience in the U.S. to risks that could readily materialize is essential to building confidence in a sustained global recovery from the pandemic. New legislation would be helpful in a number of dimensions—especially in reworking how FSOC and OFR function and making sure they are supported by a more prominent financial stability focus and analytical capability in constituent agencies. But U.S. agencies already have the tools to address many of the vulnerabilities that have lingered since the GFC and became so evident in March of 2020, and some new ones that have emerged more recently.[3]
Here’s a checklist of actions that do not require legislation. Notably, it is not a menu from which to pick a few “dishes” to make a macropru meal—all of these things should be addressed, and promptly.
Banking
The resilience of the banking sector was greatly strengthened after the Global Financial Crisis (GFC) by tightened and reformed capital requirements, stress tests of capital adequacy, liquidity requirements, and greater scrutiny of bank risk-management practices, with extra requirements in each area for systemically important banks whose failure would have significant knock-on effects. But more can be done to build resilience in banks and in securities markets where banks intersect with nonbank finance.
A very serious amplifier of stress in the March 2020 dash for cash was the counterintuitive and counterproductive behavior of Treasury securities prices, which fell, rather than rose, in the midst of a flight to liquidity and safety. Dysfunction in the Treasury market spills over in many ways to the broader financial markets and the economy since Treasuries are relied on for liquidity by market participants, for risk management, and as a pricing reference point. There were a number of contributors to this behavior, but one was the reluctance of private dealers, the largest of which are subsidiaries of systemically important bank holding companies, to flex their balance sheets to pick up the Treasury securities being offered in the market. The dealers were especially constrained by the risk-insensitive leverage ratio applied to systemically important bank holding companies, until the Federal Reserve temporarily exempted deposits at the Fed and Treasuries from its calculation. That exemption has lapsed, and with continuing Fed securities purchases, deposits at the Fed are a growing threat to making the leverage ratio salient again, which would constrain dealer market-making appetite. The Federal Reserve should permanently exempt deposits at the Fed from calculation of the leverage ratio.
This exemption, however, should not be allowed to reduce the capital required of banks, especially systemically important banks. There are a number of ways to keep this from happening, but one I favor is to raise risk-based requirements a bit on average through the cycle by activating the countercyclical capital buffer (CCyB). The Fed’s current practice is to leave this at zero unless it has identified the risk environment as already elevated. In this, it differs from many other authorities globally, who have targeted a positive CCyB in a normal risk environment, which enabled them to release that capital to back lending when the Covid-related shut down hit.
The argument for an active CCyB has been strengthened by experience in the pandemic. Evidence from both the U.S. and EU is that banks are reluctant to dip into their regulatory capital buffers to make loans under stress out of concern about market reactions and about supervisory constraints on earnings distributions. Studies have shown that banks with less headroom over buffers tended to lend less in the pandemic than banks with more headroom.[4] The beauty of the CCyB is that once released, it is not part of a regulatory capital buffer and is more available for use. Moreover, the recent changes to the Fed’s stress tests and capital requirements, including substituting a “stress capital buffer” derived from stress test results for elements of the capital stack, are likely to make capital requirements procyclical; adding an actively managed CCyB would counter this adverse macroprudential outcome.
The evident reluctance of banks to dip into regulatory buffers under stress suggests a reasonably sizable CCyB in “normal times” to release under stress would be a helpful countercyclical measure from a macroprudential perspective. The Financial Policy Committee at the Bank of England has established two percent as its target CCyB in a standard risk environment, twice what many other macropru authorities have set, in part by shifting capital from other elements of the stack.
The Federal Reserve should make the CCyB positive in normal risk environments and then manage it actively as risks build or materialize. As it implements a CCyB, the Fed should consider the appropriate level in the context of sterilizing a potential release of capital from adjusting the leverage ratio and the composition of the overall capital stack that would best support the resilience of the financial system and the economy.
Market-based finance
Credit has increasingly shifted to nonbank channels, especially to markets, responding to innovation and to regulatory arbitrage as bank regulation tightened. But elements in nonbank finance share the leverage and maturity and liquidity transformation characteristics of banks, making them also vulnerable to runs and fire sales that tighten credit and amplify business cycles. In many respects, however, vulnerabilities in market-based finance are harder to deal with than they are with banks. They are spread over many types of institutions and markets, subject to multiple regulators—and some parts are very lightly regulated, if at all. Market-based finance is global, facilitating arbitrage across borders and necessitating a globally agreed approach to regulation. And rapid technological change produces a constantly evolving set of instruments and players. Still, tools are available to address a number of vulnerabilities and the centrality of U.S. markets to global markets means that the U.S. should lead the effort.
As noted, well-functioning U.S. treasury markets are a critical element in keeping both bank and nonbank financing channels operating well. Leverage ratio reform is a necessary but not sufficient condition to bolstering Treasury market liquidity. In addition, the Treasury and the Fed should examine the costs and benefits of mandating central clearing for Treasuries and repos, which might free up dealer capital that would be available to be used for market making.[5] And the agencies need to gather and publish more complete data on market transactions to help both regulators and market participants better understand and anticipate market dynamics.[6]
Even with greater private-sector market making, circumstances could arise in which the Federal Reserve would need to step in to preserve well-functioning Treasury securities markets. To that end, backstop standing repo facilities for foreign official holders of Treasuries and for a wide variety of private market participants would put structures in place that could fill that role in a well-anticipated and transparent fashion. In that regard, the Federal Reserve’s recent announcement of two such facilities—one for foreign official institutions and another for dealers—was welcome.
But the repo facility for private parties is limited to the primary dealers and, over time, some depository institutions. To better guarantee Treasury market functioning, the Federal Reserve needs to design a repo facility that is available to a variety of large participants, like hedge funds and other leveraged investors that are playing an increasingly important role in the market. Such an extension would raise issues of counterparty risk and distortions to risk-taking incentives among lightly regulated entities; those can be dealt with through varying haircuts and by imposing a small ex ante fee on lightly regulated entities with access to the facility, but other approaches may also work.
Several types of open-end funds faced very large redemptions in March, including both money market funds and corporate bond and loan funds; to meet those demands, funds turned in part to selling the Treasuries they held for liquidity purposes, so these redemptions disrupted Treasury, corporate bond, and commercial paper markets. The scale of the redemptions is not surprising. Many mutual funds offer their investors much greater liquidity—an ability to redeem by tomorrow at tonight’s closing price—than the liquidity of the underlying securities they hold, which often trade in illiquid markets or simply don’t trade at all, like commercial paper. This mismatch creates a first mover advantage—an incentive to get out while the fund has Treasuries to sell—before redemptions by other investors force fire sales of less liquid assets, depressing prices. The SEC must change regulations to align the liquidity offered investors with the liquidity of the underlying assets in the fund. There are a variety of ways to do this—and the choice for money market funds might differ from the best choice for bond funds. Swing pricing forces early redeemers to pay the price of the liquidity they are getting; where that isn’t possible, as is argued for money market funds, alternatives may work to properly price liquidity under stress, like penalizing redemptions under some circumstances or holding back a portion of the investment.
Another source of elevated demand for liquidity in March 2020 arose from initial margining at central counterparties in derivative and securities markets. According to users, a lack of transparency and predictability about margining methodologies contributed to unexpected demands for cash during the “dash for cash.” But in addition, margin requirements rose substantially as markets became much more volatile. From the perspective of the clearinghouses, this made good sense, and in fact central counterparties remained functioning and viable during an extremely stressful market episode. But here is a case of the micro and macroprudential impulses in conflict as the interest of each clearinghouse added to overall market stress. The CFTC and the SEC should draw on the systemic perspectives of the Fed and Treasury to make margins in CCPs less procyclical with more through-the-cycle methodologies.
This is a formidable list—and I could have added more. Much of it is already under consideration in the U.S. and in global groups, like the FSB. Each element will draw opposition from private parties fearing added costs and counting on intervention from the fiscal and monetary authorities to contain the next market crisis. All of it will require a careful balancing of costs and benefits—but most explicitly and importantly taking account of the costs to society, beyond the costs to market participants, of repeated episodes of financial instability.
Other jurisdictions
The risk environment in the financial markets of many other advanced economies is quite similar to that facing the U.S. Asset prices are elevated and leverage in some sectors has ballooned as market participants count on low interest rates persisting for a very long time. But uncertainties abound as the global economy emerges from a global pandemic after application of unprecedented monetary and fiscal policies. And, until the U.S. raises its macropru game, they are vulnerable to disruptions emanating from U.S. markets.
Many authorities outside the U.S. have utilized a wider array of macropru tools than has the U.S. Given the risk environment, now is the time to make sure domestic institutions and markets would be resilient to severe shocks. Where requirements were adjusted or eased in response to the onset of the pandemic, they should be restored to former settings now that economies are recovering and credit is flowing readily. For example, CCyBs cut in March 2020 to encourage bank lending should be raised as quickly as is consistent with the commitments and forward guidance given when the reductions were announced. Where the “dash for cash” revealed new vulnerabilities that can be addressed in individual jurisdictions, actions should be taken to build resilience—for example, if the margining at CCPs and the behavior of highly leveraged investors in domestic sovereign bond markets amplified stress. Where effective remediation is not possible in global markets without the participation of the U.S., other authorities should work closely with U.S. authorities in international fora to build consensus around best practices that can be implemented globally, including in the United States.

[1] Darrell Duffie highlighted the potential for central clearing to economize on dealer capital. https://www.brookings.edu/research/still-the-worlds-safe-haven/
[2] Notably, the recommendations of the G-30 group on Treasury market functioning are broadly aligned with those of the Task Force. https://group30.org/publications/detail/4950
[3] https://www.federalreserve.gov/econres/feds/un-used-bank-capital-buffers-credit-supply-shocks-at-SMEs-during-the-pandemic.htm. And for similar findings away from the U.S.: https://www.bis.org/bcbs/publ/d521.pdf.
[4] https://www.federalreserve.gov/newsevents/pressreleases/monetary20210818a.htm
[5] https://www.ft.com/content/32a57864-d983-46b0-bbfa-85fd2d2361e5
[6] Much (though not all) of what follows is based on the recommendations of a Chicago Booth-Brookings Task Force on Financial Stability that I co-chaired. https://www.brookings.edu/research/report-of-the-task-force-on-financial-stability/. I have also drawn on my talk to the Kansas City Fed’s Jackson Hole symposium. https://www.brookings.edu/research/building-a-more-stable-financial-system-unfinished-business/

Technological capacity and firms' recovery from Covid-19

by Sebastian Doerr, Magdalena Erdem, Guido Franco, Leonardo Gambacorta and Anamaria IllesBased on a large sample of firms in 17 countries, this paper shows that businesses headquartered in countries with better digital capabilities – as measured by their position in the World Digital Competitiveness Ranking – had higher revenues during the pandemic relative to their pre-pandemic trend.