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The push to buttress the U.S. Treasury securities market at the heart of the global financial system and make it more resilient to shocks received fresh impetus on Tuesday with the release of a blue-ribbon report.

The Task Force on Financial Stability — a joint initiative of the Brookings Institution and the University of Chicago — calls for loosening liquidity constraints on banks to make it easier for them to make markets in U.S. government debt. It also supports the establishment of a standing repurchase facility for Treasuries at the Federal Reserve to serve as a backstop for the system in times of stress.

“The Treasury market is the foundational market for other financial markets, not only in the U.S. but around the world,” said former Fed Vice Chair Donald Kohn, who, along with ex White House chief economist Glenn Hubbard, was co-chair of the team that compiled the report. “It is important really to fix that.”

Dash for Cash

The fragility of the market was highlighted by the March 2020 dash for cash by investors spooked by the spread of Covid-19. Trading in Treasuries — normally seen as a safe haven in times of crisis — all but seized up as the market was swamped by waves of selling, forcing the Fed to step in and buy more than $1 trillion worth of debt to restore calm.

Besides tackling dysfunction in the Treasury market, the 134-page report also addresses other weaknesses in the financial system that were exposed by March 2020’s market mayhem, with a particular focus on non-banks.

The task force wants prime money market funds — which invest in both corporate and government notes –to adopt swing pricing and redemption fees to lessen the risk of investor runs that drain them of resources. It also advocates that the Federal Housing Finance Agency be made the prudential regulator for non-banks that oversee the servicing of mortgage loans, taking over the task from states.

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To help ensure the stability of the system in the longer run, the report backs a stronger role for the Financial Stability Oversight Council, the inter-agency committee set up after the global financial crisis and which is headed by the Treasury secretary.

Every member of the FSOC, including the Securities and Exchange Commission, should be given a mandate by Congress to promote financial stability and should be required to submit proposed regulatory changes to a new agency — the Comptroller for Data and Resilience — for review, the report found.

Right Incentives

“It’s about getting incentives right and a regulatory process that can see around corners,” Columbia University professor Hubbard said in a press briefing on the report.

He said the task force had spoken to a number of regulators and that they were receptive to the overall thrust of the report that something needed to be done to try to avoid a repeat of the March 2020 market meltdown.

Kohn, who is now with Brookings, said he was encouraged by news that the Fed is considering establishing a standing repo facility. At the April meeting of the central bank’s Federal Open Market Committee, a “substantial majority” of policy makers saw potential benefits from such a facility, according to the minutes of the gathering.

Under the task force’s proposal, non-banks with a significant presence in the Treasury market, including hedge funds, would be required to participate in the facility and pay an up front fee for the liquidity they’d need in emergencies, though it didn’t suggest how much.

In line with another recommendation in the report, the Fed is also considering altering some of its bank liquidity requirements. “We’re looking hard at the issue,” Fed Chair Jerome Powell told reporters on June 16, while declining to give a timetable for a decision.

The task force said regulators should permanently exclude bank reserves from the Supplementary Leverage Requirement or consider adopting the global leverage standard for big U.S. banks. It also called on regulators to study the costs and benefits of a central clearing requirement for Treasuries and Treasury repurchase agreements.

“The market participants we’ve talked to are very much on the page that the Treasury repo central clearing could save capital, releasing it for use in market-making,” Kohn said.

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