Various academic studies have suggested indirect ways in which restrictions on short- term funding might be implemented. Many of these proposals are aimed at reforming the use of repurchase agreements and money market funds, which dominate the short-term
financing markets, as asset backed commercial paper has largely disappeared as a funding instrument for financial institutions.34
One proposal is to reduce banks’ reliance on short term funding by rolling back 2005 amendments to the Bankruptcy Code that added repurchase agreements on mortgage- related assets to the exemptions from the automatic stay, the normal bankruptcy rules preventing the seizure of collateral.35 Prior to 2005, collateral in repurchase agreement transactions eligible for the automatic stay was limited to US government and agency securities, bank certificates of deposits, and bankers’ acceptances. Rolling back this new exemption would arguably increase counterparty risks on these repurchase agreements thereby reducing the willingness of financial institutions to enter into them for short- term funding. Moreover, narrowing the safe harbors to only the most predictably liquid securities can help prevent these exemptions from exacerbating a liquidity crisis.36 Although safe harbors are designed to insulate counterparties from default at the individual level, they can actually function to aggravate liquidity problems, as they facilitate “panic selling.”37
Other proposals also focus on repurchase agreements, including calling for strict regulation of securities used as collateral in repurchase agreements, limiting such collateral to only the highest quality securities for banks.38 One study has found that during the 2008 financial crisis, the contraction in repurchase agreements played a significant role for systemically important dealer banks. For example, nearly half of the repurchase agreements of Merrill Lynch, Goldman Sachs, and Citigroup with money market funds were backed by nonagency MBS/ABS and corporate debt, and almost all of this financing disappeared during the crisis.39 The FSB has recommended that regulators consider mandatory haircuts on collateral for all repurchase agreements.40
Another future Fed action that could potentially affect the short-term funding market is the Fed’s impending implementation of restrictive margin requirements for securities financing transactions.41 While the Fed’s main objective with the restrictions would likely be to address asset bubbles, higher margin requirements would directly reduce the
amount of short-term funding that can be obtained with a given amount of collateral. The Office of Financial Research estimates this market to be $4.4 trillion.42 However, the effect of higher margin requirements on short-term funding markets will be dampened because the new rules will likely exempt Treasurys and agency securities, which make up two-thirds of the market.43 Regardless, as the increased restrictions limit the use of a portion of the securities financing market, the effect may be an overall increase in unsecured borrowing. Substituting unsecured borrowing for secured borrowing will consequently expose the financial system to greater risk, not less, which should be seriously considered as an unintended consequence in the wrong direction.
Notes
1. See generally Daniel K. Tarullo, Governor, Fed. Res. Bank of San Francisco Conference on Challenges in Global Finance: The Role of Asia, San Francisco, California (Jun. 12, 2012), available at
http://www.federalreserve.gov/newsevents/speech/tarullo20120612a.htm.
2. See Jack Bao, Josh David, and Song Han, The runnables, Fed Notes (Sep. 3, 2015), available at http://www.federalreserve.gov/econresdata/notes/feds-notes/2015/the- runnables-20150903.html.
3. Data derived from unpublished manuscript of Morgan Ricks, Fed. Res., Credit market debt outstanding (Mar. 12, 2015), available at
http://www.federalreserve.gov/releases/z1/current/accessible/l1.htm.
4. See http://www.federalreserve.gov/releases/cp/volumestats.htm (accessed Jun. 2, 2015); and see Fed. Res. Flow of Funds L.4 line 2. From this we assume an even distribution of maturity between 21 and 40 days, giving 84.68 percent of weekly
issuance with a maturity of 30 days or less. At the end of 2014, there was $930.4 billion in commercial paper outstanding, giving an estimate of $787.9 billion = 84.68% ×
$930.4 billion of runnable commercial paper.
5. US Dept. of Treas. Office of Financial Research, Repo and securities lending: Improving transparency with better data 1 (Apr. 23, 2015), available at
http://financialresearch.gov/briefs/files/OFRbr-2015-03-repo-sec-lending.pdf.
6. According to the flow of funds, there was $3,699.8 billion in repo at the end of 2014, see Fed Flow of Funds Z.1 L.207 line 1; The Fed had $509.8 billion in repo liabilities at the end of 2014, see Fed Flow of Funds Z.1 L.207 line 2.
7. The Treasury-backed repo portion was (0.244 * 0.977) * 3,190.0 billion = 760.5 billion.
8. See Copeland, Martin, and Walker, Repo runs: Evidence from the tri-party repo market, J. Fin. (2014) 69–6.
9. Total domestic deposits of $10,367.9 billion less $6,131.9 billion of insured deposits less
$1,699 of time deposits. See FDIC Quarterly Banking Profile Balance Sheet Spreadsheet line 50 available at https://www2.fdic.gov/qbp/index.asp for total domestic deposits; FDIC Quarterly Banking Profile at 25 Table III-C available at
https://www.fdic.gov/bank/analytical/quarterly/2014_vol8_4/FDIC_Quarterly_Vol8No4.pdf for insured deposits; and FDIC QBP Balance Sheet Spreadsheet line 56 for time
deposits.
10. Fed Flow of Funds Z.1 L.131 line 20.
11. See Tobias Adrian, Brian Begalle, Adam Copeland, and Antoine Martin, Repo and securities lending, Fed. Res. Bank of NY Staff Report No. 529 (February 2013).
12. http://www.ici.org/research/stats (accessed Jun. 3, 2015).
13. As discussed in the body of the text, we adjust the $10.6 trillion by subtracting non- runnable components. $1.7 trillion of time deposits is removed, $100 billion of
commercial paper with a maturity longer than 40 days is removed, $500 billion of reverse repo with the Federal Reserve is removed, and $230 billion of reverse repo with a maturity greater than 30 days is removed.
14. This represents $1,565.5 of net repo lending from large cash investors less $393.8 billion of Fed RRP. See Flow of Funds Z.1 L.121 line 5 for MMMF repo; Flow of Funds Z.1 L.122 line 2 for mutual fund repo; Risk Management Association Quarterly
aggregate composite for securities lender repo; Flow of Funds Z.1 L.124 lines 4, 26 for GSE repo; and Flow of Funds L.100 line 7 for domestic nonfinancial sector repo. See http://www.newyorkfed.org/markets/omo/dmm/temp.cfm
15. The Treasury-backed repo portion was (0.244 * 0.977) * 1,171.7 billion = 279.3 billion.
16. Treasury Direct, Historical debt outstanding—Annual 2000–2014, available at http://www.treasurydirect.gov/govt/reports/pd/histdebt/histdebt_histo5.htm;
TreasuryDirect.com, The debt to the penny and who holds it (2015), available at http://treasurydirect.gov/NP/debt/current.
17. At the end of 2014 there was $2.935 trillion US government debt with a maturity less than one year. At the end of 2013 there was $1.523 trillion US government debt with a maturity between one and two years. The debt with a maturity of one-to-two years in 2013 transitions to a maturity of zero-to-one years in 2014. Hence $1.412 trillion of the
$2.935 trillion with a maturity of less than one year was issued with a maturity of less than one year. Office of Debt Management, Fiscal Year 2015 Q1 Report 1, 26, 28
(2015), available at http://www.treasury.gov/resource-center/data-chart- center/quarterly-
refunding/Documents/February2015CombinedChargesforArchives.pdf.
18. Federal Reserve, Credit and liquidity programs and the balance sheet (2015), available at http://www.federalreserve.gov/monetarypolicy/bst_recenttrends.htm.
19. International Monetary Fund, Global Financial Stability Report 80–81 (Oct. 2014).
20. Id. at 5.
21. Cardiff Garcia, Cash Pools, Fed rev-repos, and the stagnationist future, part 1, Fin.
Times, Alphaville (Jul. 3, 2014), available at
http://ftalphaville.ft.com/2014/07/03/1890002/cash-pools-fed-rev-repos-and-the- stagnationist-future-part-1/.
22. International Monetary Fund, Global Financial Stability Report 80 (Oct. 2014).
23. See, for example, Robin Greenwood, Samuel G. Hanson, and Jeremy C. Stein, A comparative-advantage approach to government debt maturity, J. Fin. (forthcoming) (2015); see also Mark Carlson, Burcu Duygan-Bump, Fabio Natalucci, William R.
Nelson, Marcelo Ochoa, Jeremy Stein, and Skander Van de Heuvel, The demand for short-term, safe assets and financial stability: Some evidence and implications for central bank policies (Fed Working Paper 2014), available at
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2534578.
24. See, for example, Jeremy Stein, Monetary policy as financial-stability regulation, 127 Q. J. Econ. (1): 57–95 (2012).
25. Financial Stability Oversight Council, 2013 Annual Report, Chart 5.2.3 (2013), available at
http://www.treasury.gov/initiatives/fsoc/Documents/FSOC%202013%20Annual%20Report.pdf 26. Daniel Tarullo, Industry structure and systemic risk regulation, Remarks at the
Brookings Institution Conference on Structuring the Financial Industry to Enhance Economic Growth and Stability (Dec. 4, 2012).
27. Id. at 10.
28. Id.
29. Id.
30. Financial Services (Banking Reform) Act of 2013, Section 142Y(1).
31. See, for example, Asli Demirgỹỗ-Kunt and Harry Huizinga, Bank activity and funding strategies: The impact on risk and returns, 98 J. Fin. Econ. 626 (Dec. 2010) (finding short-term nondeposit funding increases certain measures of bank fragility); Lev Ratnovski and Rocco Huang, Why are Canadian banks more resilient? (IMF Working Paper 09/152, Jul. 2009) (finding that the ratio of depository funding to total assets was an “important predictor of bank resilience during the turmoil”).
32. IMF, Global Financial Stability Report (Apr. 2009).
33. See German López-Espinosa, Antonio Moreno, Antonio Rubia, and Laura Valderrama, Short-term wholesale funding and systemic risk: A Global CoVaR approach, 36 J. Bank.
Fin. (2012).
34. Thomas Hoenig and Charles Morris, Restructuring the banking system to improve safety and soundness (May 2011), available at
https://www.fdic.gov/about/learn/board/restructuring-the-banking-system-05-24- 11.pdf.
35. Id.
36. Edward Morrison, Mark J. Roe, and Christopher S. Sontchi, Rolling back the Repo safe harbors, Business Lawyer 1, 14–15 (Jul. 3, 2014), available at
http://www.newyorkfed.org/research/conference/2014/wholesalefunding/RollingBacktheRepoSafeHarbors_Roe.pdf
37. Id.
38. Gary Gorton and Andrew Metrick, Regulating the shadow banking system, 41 Brookings Papers on Econ. Activity 261 (2010).
39. Arvind Krishnamurthy, Stefan Nagel, and Dmitry Orlov, Sizing up repo (NBER Working Paper 17768, Jan. 2012).
40. Fin. Stability Bd., Shadow banking: Strengthening oversight and regulation 23 (Oct.
27, 2011), available at http://www.financialstabilityboard.org/wp-
content/uploads/r_111027a.pdf?page_moved=1. See also John Geanakoplos, The leverage cycle (Cowles Found., Discussion Paper 1304, 2010), available at
http://cowles.econ.yale.edu/~gean/art/p1304.pdf.
41. Ryan Tracy, Fed eyes margin rules to bolster oversight, Wall St. J (Jan. 10, 2016).
42. Id.
43. Id.
21 Government Crowding Out of Private Issuance of Short-Term Debt
Some have suggested that the government should increase the effective supply of public short-term debt in order to meet the demand by institutional cash managers for safe short-term debt. In the extreme case, if the government eliminated private issuance of short-term debt by issuing enough public short-term debt to satisfy this demand, then there could be no runs and no contagion. The same result could be achieved if the remaining short-term debt of the financial system was so small that runs would not be significant. These policies can be characterized as “crowding out” private short-term debt.