Money, Banking, and Financial Markets

Understand the principles, understand the future

In the aftermath of Britain’s July 2016 vote to exit the European Union, six U.K. open-end property funds with nearly £15 billion in assets suspended redemptions. These funds had routinely engaged in an extreme version of liquidity transformation: offering investors the ability to convert their shares into cash daily on demand, while holding highly illiquid commercial properties. Fortunately, the overall sector was small, and its post-referendum disruption neither spilled over broadly to funds holding other assets, nor prompted a wave of fire sales that might have undermined the balance sheets of leveraged intermediaries. Nevertheless, the episode was of sufficient concern that the U.K. Financial Conduct Authority (FCA) is now reviewing its “regulatory approach to open-ended funds that invest in illiquid assets” (see here).

The FCA is not alone in its concerns. Other regulators have been looking closely at risks associated with the liquidity transformation performed by open-end funds. And, interest in the official sector has been accompanied by a wave of academic research on liquidity management in open-end funds that generally buttresses the regulators’ concerns. In this piece, we briefly highlight the work of the regulators, summarize the research, and finally reprise our proposal to convert open-end funds into exchange-traded funds (ETFs).

In 2012, the ECB faced down a mortal threat to the euro: fears of redenomination (the re-introduction of domestic currencies) were feeding a run away from banks in the geographic periphery of the euro area and into German banks. Since President Mario Draghi spoke in London that July, the ECB has done things that once seemed unimaginable, helping to support the euro and secure price stability.

So far, it has been enough. But can the ECB really do “whatever it takes”? Ultimately, monetary stability requires political support. Without fiscal cooperation, no central bank can maintain the value of its currency. In a monetary union, stability also requires a modicum of cooperation among governments.

Recent developments in France have revived concerns about redenomination risk and the future of the euro....

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Further commentary, click here.

Welcome to ...

... the site where you can learn about finance and economics. We provide commentary on events in the news and on questions of more lasting interest. Because the financial system is constantly evolving, our analysis is informed by a set of core principles: understand the principles, understand the future. The opening excerpts of our two most recent posts appear above. For prior posts, click on the Commentary link to the left, or on the month-by-month Archives to the right. Alternatively, if you are interested in a specific topic, use the tags.

The site also provides material related to our textbook, Money, Banking and Financial Markets, 5th edition, 2017. The Five Core Principles on which the book is based are highlighted here. In addition, Cecchetti and Schoenholtz 5e systematically integrates the use of economic and financial data from FRED, the online database provided by the Federal Reserve Bank of St. Louis. Click on FRED Lessons on the left to access help on how to use this incredible resource.

Steve Cecchetti and Kim Schoenholtz

The work on this site is protected by the Creative Commons Attribution 4.0 International Public License. It may be copied, redistributed, remixed, transformed, or built upon for any purpose, so long as the work is attributed to Cecchetti and Schoenholtz,, and any changes are indicated.



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