In fact, economists sometimes refer to money market instruments as "near money" or "quasi money." Nor is there any consensus on how the government should respond in the event of a future money market panic. Because deposits and money market instruments share this special characteristic, this article refers to them together as "money claims".
TAKING THE MONEY MARKET SERIOUSLY
The new "Orderly Liquidation Authority" (OLA), which is the centerpiece of the new law, was not designed to deal with the problem of non-payment of monetary claims. Rather, the FDIC insists that monetary creditors will be defaulted "in almost all cases."12) Instead, the OLA was designed to preserve the value of the assets of failed financial firms until they were liquidated—a worthy goal, but a very different one. At the same time, the Dodd-Frank Act introduced significant new restrictions on the government's independent anti-panic tools.
Prelude: "Shadow Banking" and the Panic of 2008
It was only when this regime bypassed the shadow banking system that unstable conditions re-emerged. See e.g. Gary Gorton & Andrew Metrick, Regulating the Shadow Banking System (Nat'l Bureau of Econ. If the shadow banking system played a prominent role in the recent crisis, it was also at the heart of the government's re-emergency response.
What's Different About the Money Market?
34; "Capital Preservation Investment" is defined as "an investment made to preserve capital and liquidity until the funds are used in the issuer's principal business or businesses." 17 C.F.R. The original order from which this exemption derives involved a biotechnology company whose balance sheet assets consisted primarily of of "high-quality short-term government and commercial debt instruments"—that is, money market instruments. But in the case of money market instruments, that is precisely what our regulatory system has done. 34 ;money claims." This functional term is intended to include all short-term, high-quality financial instruments in the financial system - whether collateralized or not, and regardless of the identity of the issuer.
The Economic Value of Maturity Transformation
MARKET FAILURE AND THE CASE FOR GOVERNMENT
The Trouble with Money-Claim Defaults
Under normal conditions, as we have seen, this problem does not arise due to the law of large numbers. According to one of the main works of economic theory in this area, "agents will choose to deposit at least part of their wealth in the bank even if they foresee a positive probability of a run, provided that the probability is small enough. ". Federal Reserve Chairman Ben Bernanke reportedly warned congressional leaders at the height of the latest crisis that, unless they pass a bailout bill, "we may not have an economy on Monday.
If an overcollateralized repo creditor liquidates its collateral and thereby generates proceeds in excess of the nominal amount. If the prices of all assets in the economy cannot immediately adjust to the reduction in the money supply, real consumption and investment will be lower than they would be in the absence of monetary adjustment. Rather, it is the most widely accepted account of the root cause of the Great Depression.
In their magisterial monetary history, Milton Friedman and Anna Schwartz traced the origins of the Great Depression to a drastic monetary contraction caused by successive waves of bank failures. 34;[As I have always tried to make clear," he has said, "my argument for non-monetary impacts of bank failures is simply an embellishment of the Friedman-Schwartz story; that in No. Critically, these consequential losses are separate from any losses attributable to the impairment of the instruments themselves.
Here Bagehot is again a reliable guide: "[U]ltimate payment is not what the creditors of a bank want; they want present, not deferred, payment; they want to be repaid according to agreement; the contract was that they must be paid on demand, and if they are not paid on demand they may be ruined."6 9 The instrumental value of money claims and the consequent losses incurred when their issuers default are two sides of the same coin.
Collective Action and Market Failure
But why should we worry about the direct damage to the affected money claimants themselves? If the deal were fulfilled, it would prevent an uncoordinated attack on the issuer: individual money claimants would be contractually barred from trying to get "to the front of the line" if they got the impression that the company was in trouble. If moneylenders waited until liquidity problems arose before starting to negotiate, it would be too late: bargains take time and runs are fast.
More realistically, the issuing firm itself could require all its money claimants to agree to the terms of this bargain before depositing. Even a modest distortion by a significant number of money claimants would deplete the issuer's cash reserves, which are equal to only a small fraction of its outstanding money claims. And the sheer number of money claimants—a necessary prerequisite for the operation of the law of large numbers that makes maturity transformation possible in the first place—presents formidable problems when it comes to policing and enforcing compliance.
It is not that government intervention is unjustified because creditors have "accepted the risk" of default. Creditors know that they will experience consequential damages in the unlikely event of an issuer's default. If this insurance policy were reliable, a market solution would be available to money claimants without any need for government intervention.
The government does not need to remove monetary claims from circulation in order to provide insurance for monetary claims.
Policy Alternatives (and a Brief History of U.S. Bank
WHAT THE DODD-FRANK ACT MEANS FOR THE MONEY
The Mechanics of "Orderly" Liquidation
Before the creation of the FDIC, bank failures were handled under insolvency regimes that treated depositors as ordinary creditors. Second, by virtue of deposit insurance, the FDIC's insurance fund bore most of the potential downside of bank failures. First, the FDIC, in its corporate capacity as insurer, protects all of the failing institution's depositors.
Second, the FDIC acts as the trustee of the failed institution and administers the conservatorship estate for all creditors. It is the FDIC as the insurer that ensures that the negative monetary consequences do not occur. Specifically, the OLA legislation gives the FDIC the power to make “additional payments” to third parties if certain conditions are met.2 Presumably, this power could be invoked to honor monetary claims, at least some of the time.
However, it is important that the FDIC can make additional payments to creditors only under certain circumstances. In implementing a receivership agreement, the FDIC must borrow from the Treasury Department—and these loans are not unconditional. Thus, even if the FDIC wanted to make prompt payments to money claimants and was satisfied that it had the legal authority to do so under.
122 The FDIC has indicated that it will "exercise care" in evaluating collateral and that it.
The Government's Refashioned Emergency Powers
In fact, the Federal Reserve's lending programs have been deployed to support every major component of the money market: the dealer repo market (through the PDCF program), the commercial paper market (through the CPFF program), the asset-backed commercial paper market (through the AMLF program), the money market fund industry (through the MMIFF program) and the Eurodollar market (through currency swaps with foreign central banks). Section 13(3) of the Federal Reserve Act28, which gives the central bank the authority to lend money to any company – not just custodians – under “unusual and exigent” circumstances. Second, the Dodd-Frank Act requires the Federal Reserve to obtain prior approval from the Secretary of the Treasury before establishing a 13(3) lending program in the future.130.
One of the fundamental (and unnerving) lessons of the recent crisis was that central bank lending was not sufficient. An equally critical part of the federal government's emergency response—and the largest, as measured by total dollars pledged—was a series of guarantee measures. grams established by the FDIC and the Treasury Department. Finally, in the largest dollar commitment of the crisis, the Treasury Department guaranteed more than $3 trillion in MMF liabilities – a dramatic and decisive move that successfully stabilized the core of the shadow banking system.
Implementation of any of the guarantee programs deployed during the recent crisis would require an act of Congress. But neither the Dodd-Frank Act itself nor any other post-EESA legislation has restored the ability of any branch of government to respond forcefully in the event of a run on this $3 trillion industry – the fulcrum of the shadow banking system. . We have seen above that the Treasury's guarantee for the MMF sector in 2008 rested on what could be considered a rather expansive interpretation of its statutory powers.
He recited the limits of the Fed's legal authority even in "unusual and urgent circumstances."
The Ghost of Crisis Yet to Come
This was a deliberate policy decision and necessarily means that the next money market panic is not excluded. Money seekers still have ample reason to withdraw funds at the first sign of stress - to get to the top of the line. Activation of the OLA requires the approval of two-thirds of the FDIC and Federal Reserve boards, the Secretary of the Treasury, in consultation with the President, and, if the firm does not consent, a federal district court judge.144 Bankruptcy is the default option, and bankruptcy means long delays and possible damage to money claims - it is a source, not an answer, to the subsequent losses of money claimants.
In pursuit of additional returns, these funds have significantly increased their exposure to the short-term credit instruments of the largest European banks. But the goal was to try to elucidate one view of the problem and try to trace some of the implications of the policy choices we made. All social events have many causes, but some aspects of the world are more readily amenable to policy intervention than others.
A fair standard for overturning market outcomes must amount to a judgment that the benefits of the chosen intervention are likely to exceed the costs. It is the invocation of the supposed inevitability of financial crises, the defeatist notion that we are dealing with problems of human nature (or even - in the case of "animal spirits" - inhuman nature!) that we cannot hope to truly not correct. , only to resist by any inadequate means available. The hope is always that the action taken will at least do no harm - that the cost of the chosen intervention will not be that great.
Given that these two types of financial institutions were at the epicenter of the recent financial crisis, perhaps this should not be of much concern.
