New regulations meant to keep the financial system safer may be limiting firms’ ability to facilitate trades and keep markets functioning, Federal Reserve Governor Jerome Powell said Monday.
Regulation “may be one factor driving recent changes in market-making,” Powell said in discussing bond markets at the Brookings Institution in Washington. “Requiring that banks hold much higher capital and liquidity and rely less on wholesale short-term debt has raised funding costs.”
Powell’s statement comes amid a debate within the financial industry about the possibility that the new post-crisis rules have led to a lack of liquidity in certain markets, creating the possibility of wild swings in the prices of stocks and bonds leading to crises. Some Wall Street critics, on the other hand, have dismissed such concerns as efforts to roll back rules on banks and other companies.
Powell defended the new rules on the basis that they are meant to prevent economy-crushing crises.
One pertinent rule is a liquidity requirement for big banks, mandating that they own a certain amount of easily traded assets, such as Treasury securities. That and other rules may have made it more difficult for firms to sell large amounts of a stock or bond without significantly affecting prices.
While regulations may play some role in that phenomenon, so might new trading technologies such as high-frequency trading, Powell said. He noted that the speed of trading in Treasury securities has increased by more than a million-fold in recent decades.
Interactions between firms trading at high speeds using algorithms may have contributed to the wild price movements in Treasury securities on Oct. 15 last year, said Antonio Weiss, a special counselor to the treasury secretary.
Weiss, who appeared at the event alongside Powell, was previously an Obama pick for a top spot at the agency before dropping out when congressional Democrats opposed his nomination on the basis of his career in investment banking. His current role did not require congressional approval.
Weiss suggested that there might need to be minimum standards for algorithm-based traders for the sake of market safety. He also warned that the Treasury needs more data on different parts of the market for Treasury securities.
Some industry figures have suggested that the wild swings on Oct. 15 were a hint of further liquidity problems that could crop up in the future. The volatility that day was the subject of a special report from regulatory agencies in July that determined that a confluence of factors likely caused the massive swing in Treasury bond prices.
“The Treasury market is evolving, and we need not only to keep pace with events but to plan wisely for the future,” Weiss said.
