Remaking the Money Market

It is therefore up to policymakers to reduce the financial risk that the money market generates. But the prevalence of shadow banking institutions, which do not hold traditional bank charters and are not subject to bank regulation, complicates such efforts.

A full solution would focus on preventing all institutions from offering weaker forms of collateral. As at the end of last month’s Fed conference, US regulators must change the rules to prohibit mortgage-backed and other weak securities from being used so extensively in the money market, unless the government decides up front to back them fully. The weaker collateral could be used elsewhere – just not for parking money overnight. For that, safer securities should be required.

If US policymakers adopt this approach, the tone of the Fed’s next money market conference could be much more optimistic.

Mark Roe is a professor at Harvard Law School.

Copyright: Project Syndicate, 2014.