Monday, September 28, 2009

Regulators in Hilarious Move to Halt Reliance on Short-Term Funds

The credit crisis in its infancy was merely a funding crisis. In mid-2007, the normally highly liquid money markets began experiencing a pullback in lenders' eagerness to take certain forms of collateral. So Wall Street's greatest friend, the Fed, began creating a slew of new financing vehicles which offered near-unlimited funds for banks so that they could continue, if not increase, their reliance on short-term funding. Then Bear Stearns imploded, followed by Lehman, not to mention a slew of other leveraged vehicles (who have no access to the Fed) that were cut off from short-term funding when the money markets seized.

After spending a few years completely propping up the money markets, regulators now think they it's a good idea to halt banks' reliance on short-term funds. Hilarious! If regulators wanted to halt reliance on short-term funds, they maybe should've had a chat with the Fed and not allowed them to become the short-term lender of not only last resort but ONLY resort. Furthermore, borrowing short and lending long IS how banks make money. When the yield curve is steep, they print cash, when it inverts they lose money. If you take away their ability to play the yield curve, they will just raise their fees on deposits. So I suspect this plan to regulate will be met with resistance and wind up being so watered down that it becomes irrelevant.

The way to combat banks' reliance on short-term funding is to get the Fed out of the business of propping up the banking sector with super cheap funding. Make it clear that the financing vehicles they created in the past two years are being wound down and aren't coming back, and then have a plan in place to liquidate failed institutions. Spoken to Lehman or Bear lately? Funny, they don't seem to have any funding problems anymore.