Perhaps the most direct way to reduce runs related to unstable funding is to require financial organizations dependent on unstable funding to hold significantly more capital than they would if they used stable sources of funding… To reduce run risk, a larger share of long-term subordinated debt could also be utilized to finance securities positions. Long-term financing reduces the need for short-term and more “runnable” funding. While some broker-dealers have utilized long-term financing to reduce run risks, paradoxically, other broker-dealers have been reducing their use of more stable sources of financing.
Another way to minimize run risks would be to limit the amount of maturity transformation that can be done with repurchase agreements specifically. This would call for limiting the extent to which short-term repurchase agreements held by regulated financial intermediaries could be used to finance long-term assets or high-credit-risk assets. Alternatively, institutional investors such as money market mutual funds could, with new regulation, be prohibited from holding repurchase agreements secured by collateral that they, by rule, could not purchase.
Other remedies are possible and should be explored … One would be regulation that specifies eligible collateral for a repurchase agreement and that mandates the “haircut.” Another approach could be focused on accounting treatment – for example, perhaps repurchase agreements collateralized with less-liquid collateral should not count as a “cash and cash equivalent” to the investor.
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Allow me to mention one other possibility – a complex and likely controversial one, to be sure. In my view, the Federal Reserve’s Discount Window could theoretically provide a way of reducing liquidity risk, by providing a standing liquidity facility for broker-dealers like the primary dealer facility that was established during the financial crisis. The rationale for such a step would be rooted in the notion that market-making is as important as lending in today’s economy.
However, I realize that such an outcome seems unlikely. And at any rate a number of other steps I have mentioned – such as a significant re-evaluation of broker-dealer regulatory requirements and, particularly, much-higher solvency standards that would reduce the risk of runs – would seem to be prerequisites for such a path.
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In sum, given the widespread support provided to broker-dealers and the difficulties they encountered during the crisis, a comprehensive re-evaluation of broker-dealer regulation is
overdue.