Streetwise Professor

December 10, 2014

Regulators, Finally Getting a Clue

Filed under: Economics,Financial crisis,Politics,Regulation — The Professor @ 8:07 pm

Global regulators are concerned, and apparently mystified, by the evaporation of liquidity in bond and stock markets:

Global financial regulators worry that banks are scaling back costly market making functions and that this could leave investors stranded, as well as squeezing funds to drive economic recovery, a senior official said on Tuesday.

. . . .

David Wright, secretary general of the International Organization of Securities Commissions (IOSCO), which groups market regulators like the U.S. Securities and Exchange Commission and Germany’s Bafin, said it was an issue that was being looked at.

“We have seen a ‘Houdini’ disappearance of market makers in general,” Wright added. “First of all we have got to establish the facts, look at the markets … and see if this is a big problem … It’s a new frontier-type issue. I think it’s partly caused by some regulation, but we need to know.”

Partly caused by regulation? What was your first clue, Mr. Wright?

Between the impending Volcker Rule and more stringent capital rules and limitations on off-exchange dealing in stocks, regulators have piled restriction on restriction on market making activities. And they are shocked that liquidity is drying up?

Reminds me of a guy standing with a gasoline can and a blowtorch, and wondering just how his house caught on fire.

The article focuses on Europe, but it’s an issue in the US too. And Canada:

The Bank of Canada warned that investors in the nation’s corporate bond market may be underestimating the difficulty of selling the securities in a market downturn, putting them at risk of greater losses.

Rising holdings of corporate bonds in mutual and exchange-traded funds could exacerbate price swings if the funds are forced to sell in a rout, the central bank said in its semi-annual Financial System Review. Some market participants also “believe” dealers are reducing market-making activity, or acting as the middleman between trades, which may make it harder to unwind large positions, the bank said.

“A potential deterioration of liquidity in Canadian corporate bond markets may not be fully priced in,” according to the report. “Market trends suggest that more sizable price swings might be observed in the future than previously, should investors seek to simultaneously unwind large positions.”

In the aftermath of the post-crisis regulatory bacchanalia, the regulators are finally coming to recognize the unintended consequences of their actions. They are starting to see-sometimes rather dimly, pace Mr. Wright-that regulations intended to make the system less risky are creating new risks.

I’ve used the analogy of the Sorcerer’s Apprentice before. It’s as relevant now, as it ever was.


Print Friendly, PDF & Email


  1. Perfesser, hae you taken a gander at the 500+ pages on the latest risk retention rules? Trust me, on the CLO side it is still completely unclear how the response and what mechanisms are going to be put in place. One had to have one’s hands up one’s ass to come up with such stupidity ( which does, however, explain barney Franks roll in all this).

    Comment by sotos — December 11, 2014 @ 2:24 pm

  2. @sotos-No, I haven’t had the pleasure. Only so many hours in the day, and I have to ration the idiocy I monitor.

    Hands … or heads?

    The ProfessorComment by The Professor — December 11, 2014 @ 3:30 pm

  3. In the case of BF, I don’t imagine there was much difference. To produce such useless turgid drivel must be a war crime somewhere.

    Comment by sotos — December 11, 2014 @ 3:34 pm

  4. not only regulators but exchanges too. the diversity of strategy among the trader population isn’t there. when everyone is trying to do the same thng, moves get more violent. I am reminded of the old old days when every pork belly trader was the same way and an orderly market resembled a cadre of rats trying to get off a sinking ship.

    Comment by pointsnfigures — December 14, 2014 @ 6:25 am

  5. Craig, not to argue with the point that Volcker is so complicated no-one understands it, but on capital let’s play devil’s advocate a moment: what do you make of comments from Bank of England’s Jon Cunliffe and Basel Committee’s Bill Coen that this is an INTENDED consequence? Smaller inventories mean less risky investment banks, and one of the causes of the crisis was financial market players underpricing liquidity risk. Cunliffe said during IMF meetings in Oct that the market is STILL underpricing liquidity risk even while complaining about liquidity drying up. Funding costs and spreads before the crisis were unnaturally low because the market was overcrowded with people throwing liquidity around too cheaply until the whole edifice collapsed: are regulators wrong to try to change that?

    Comment by Philip Alexander — December 15, 2014 @ 6:56 am

  6. @Philip. Yes. It could be intended. But then why would regulators be expressing concern about it? Unless this concern is feigned.

    The ProfessorComment by The Professor — December 15, 2014 @ 8:10 pm

  7. The SEC is worried about it but not _all_ regulators. The bank regulators are not complaining. The regulatory apparatus is not monolithic.

    Comment by Andy — December 22, 2014 @ 3:39 pm

RSS feed for comments on this post. TrackBack URI

Leave a comment

Powered by WordPress