is our economy best served by this financial system or not why is it good for our society more broadly to use our central bank s balance sheet solely to support banks hedge funds and other financial actors are there more democratic alternatives t

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Well before the pandemic, the Fed injected hundreds of billions of dollars into repo markets for reasons that are unclear.

Last week, the Federal Reserve staged a large-scale intervention in short-term money markets, announcing that it would make $1.5 trillion in loans available in the coming days. It followed with a big rate cut. And this week, the Federal Reserve is going to start lending to any big corporation that needs it, an emergency measure it last took during the 2008 financial crisis. It will be lending essentially unlimited sums to hedge funds, banks, and brokerages.

These subsidies to the financial sector might make sense today, because the COVID-19 pandemic was unexpected and every sector is having problems. The central bank must act and act boldly at such a moment.

But it’s important to divide up responses to the pandemic into shocks to the system that are a necessary result of an unexpected catastrophe, and preexisting problems that we never addressed that are made worse by the outbreak. Seen in that light, what the Fed is doing looks much riskier than it first appears. While the scale of the Fed’s announcement dwarfs its preceding interventions, this was the third of its kind in just the last six months.

Before fears of a recession driven by the impact of COVID-19, there were funding squeezes in the fall and winter of 2019, caused by as-yet unidentified factors. What we do know is that we never fixed the plumbing of the financial system after the 2008 financial crisis, because it’s more profitable for certain financial actors to rely on the Federal Reserve’s balance sheet than to force them to act responsibly. Defenders of the status quo ignore the fundamental questions raised by the fact that shocks, both large and small, have required the Fed to repeatedly prop up short-term credit markets.

Without getting too technical, here’s what’s going on. You and I deposit and borrow money in a simple, regulated system. We get loans through a bank or credit card company, and deposit money in banks guaranteed by the Federal Deposit Insurance Corporation. If our bank goes under, our bank account is guaranteed up to $250,000 by the government.

But hedge funds, brokerages, and big corporations operate in a different banking system. They essentially deposit and borrow money using instruments called “repurchase agreements,” commercial paper, and money market funds, all of which are key parts of what is called the “shadow banking” sector. These instruments are mostly unregulated, which means they can cause bank runs. Indeed, the government agency charged with investigating what caused the 2008 crisis found that the lack of regulation in this shadow banking sector was a key cause of the crisis.

In 2008, after runs in the shadow banking markets, the Federal Reserve established a variety of rescue programs, lending billions of dollars to keep credit flowing between financial institutions—one of which the Fed has now reopened. But well before the pandemic, throughout last fall and winter, the Fed injected hundreds of billions of dollars into repo markets to ensure proper liquidity and keep interest rates from skyrocketing. Nobody really knows why that was necessary, and faced with today’s crisis, it’s more of an afterthought. But it speaks to the continued instability in these markets.

To be sure, short-term funding markets are smaller and more resilient now than they were during the financial crisis, but they still account for trillions of dollars in daily lending. Part of the reason for that is the Fed’s generosity, providing liquidity to the repo market. Still, the panics produced by volatile short-term funding are one of the “greatest risks to financial stability” remaining in all of nonbank credit provision. And even now, bankers are trying to roll back what rules do exist.

Defenders of the status quo ignore the fundamental questions raised by the fact that shocks have required the Fed to repeatedly prop up short-term credit markets.

In the wake of each of the episodes of turmoil in shadow lending, we have avoided asking fundamental questions about the fragile structure of our financial markets.

Please share your views on the topics below:

  1. Is our economy best served by this financial system or not? Why?
  2. Is it good for our society, more broadly, to use our central bank’s balance sheet solely to support banks, hedge funds, and other financial actors?
  3. Are there more democratic alternatives to the status quo, explain?

You are required to post one original post and 2 responses for this Discussion.

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