Facebook’s June 18 announcement that it has created a Geneva-based entity with plans to issue a currency called Libra is sending shock waves through the financial world. The stated objectives of creating Libra are to improve the efficiency of payments and to ease financial access. While these are laudable goals, it is essential that we achieve them without facilitating criminal exploitation of the payments system or reducing the ability of authorities to monitor and mitigate systemic risk. In addition, any broad-based financial innovation should ease the stabilization of consumption.
On all of these criteria, we see Libra as doing more harm than good. And, for the countries whose currencies are excluded from the Libra portfolio, it will diminish seignorage, while enabling capital outflows and, in periods of stress, accelerating capital flight.
Like Bank of England Governor Carney, we have an open mind, and believe that increased competition, coupled with the introduction of new technologies, will eventually lower stubbornly high transactions costs, improving the quality of financial services globally. But in this case, we urge a closed door…. Read More
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). Read More
U.S. capital markets are the deepest and broadest in the world, fortifying the country’s financial system and making its assets both liquid and attractive. A major part of this capital market advantage is due to the role played by mutual funds, which provide retail investors with a low-cost means of diversifying risk while earning a market return on their savings.
However, a growing class of mutual funds—those that hold mostly illiquid assets—appear to be a potential source of systemic risk. In this post we explain why, and then go on to suggest a change that is simple to implement and might mitigate the problem. Read More