Brokers Need More Rainy-day Funds: Fed’s Rosengren

MarketWatch, April 17, 2013. All Rights Reserved.

WASHINGTON (MarketWatch) — The financial health of large U.S. broker-dealers remains a significant financial stability risk five years after the financial crisis, and regulators should consider making them increase their capital buffers, said Eric Rosengren, the president of the Boston Fed Bank, on Wednesday.

“Despite the central role that broker-dealers played in exacerbating the crisis, too little has changed to avoid a repeat of the problem, I am sorry to say,” Rosengren said in a speech to a conference in New York sponsored by the Levy Economics Institute of Bard College.

“The status quo represents an ongoing and significant financial stability risk,” he said. “Broker-dealers remain vulnerable to losing the confidence of funders and counterparties should the world economy again experience a significant financial crisis.”

Some broker-dealers, like Goldman Sachs and Morgan Stanley, became bank holding companies during the crisis. Rosengren said bank holding companies with large broker-dealer affiliates might have to hold more capital than other banks to reflect the reduced stability of their liabilities during times of stress.

It is rare for Fed officials to comment on the financial health of broker-dealers.

Regulation of these firms primarily falls under the purview of the Securities and Exchange Commission.

Rosengren said he was concerned that broker-dealers represent a moral hazard, similar to “too big to fail” banks.

If there were another crisis, the Fed might have to consider relaunching emergency credit facilities that were used by broker-dealers in 2008 and 2009.

“If broker-dealers assume that they will once again have access to such government support should markets be disrupted, they will have little incentive to take the steps necessary to shield themselves from financing problems during a crisis and thus minimize their need for a government backstop,” Rosengren said.

The Fed set up two emergency facilities during the crisis. The first, the Primary Dealer Credit Facility, provided overnight loans to primary dealers in return for collateral. At its peak, lending in the program was $156 billion.

A second plan, the Term Securities Lending Facility, allowed primary dealers to lend less-liquid securities to the Fed for one month in exchange for Treasurys. The peak balance of that program was $246 billion.