Sunday, July 29, 2012

29/7/2012: Financial Markets Repression

In my recent conversation with Carmen Reinhart, we discussed at length various forms of financial repression to be unleashed onto the public with the coming systemic deleveraging in the US, EU and elsewhere. One of the most prominent topics in our discussion were potential capital controls. And we both agreed that most likely, it will be Eurozone that will be first in the races to impose such. Of course, there are signs of softer version of capital controls within the banking system already present. So much so that Mario Draghi had to identify national regulations as barriers to single market in banking under current conditions.

Never mind. The US Fed is not about to fall behind the curve. And in the latest suggestion for policymakers, the Federal Reserve Bank of New York (Staff Report No. 564, July 2012, linked here) puts forward an idea that "for money market fund (MMF) reform [to] mitigate systemic risks arising from these funds by protecting shareholders, such as retail  investors, who do not redeem quickly from distressed funds... a small fraction of each MMF investor’s recent balances, called the “minimum 

balance at risk” (MBR), be demarcated to absorb losses if the fund is liquidated."

Wait, does this mean that fund investors can face some small share loss imposed onto them because they might be quicker than other investors in exiting or more foresightful enough to spot the fund running into trouble ahead of other investors? Yep, that's right.

"The MBR would be a small fraction (for example, 5 percent)  of each shareholder’s recent balances that could be redeemed only with a delay.  The delay would ensure that redeeming investors remain partially invested in the fund long enough (we suggest 30 days) to share in any imminent portfolio losses or costs of their redemptions.  However, as long as an investor’s balance exceeds her MBR, the rule would have no effect on her transactions, and no portion of any redemption would be delayed if her remaining shares exceed her minimum balance."

And the rationale: "to reduce the vulnerability of MMFs to runs and protect investors who do not redeem quickly in crises."


That, folks, is a hell of a capital control proposal.
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