Former Treasury Secretary Larry Summers said regulators should make a priority of addressing the problems of bond market liquidity, brought on by their very efforts to make institutions safer after the financial crisis.
The drumbeat about liquidity questions in the corporate bond market but also Treasury market has gotten louder, and Dimon used his annual letter to shareholders as soap box to warn about the issue.
Bond market participants blame post-financial crisis regulations aimed at making the activities of financial institutions safer by restricting capital use. In the Treasury market, they point to the fact that the Fed holds a massive amount of Treasury supply on its more-than-$4 trillion balance sheet, keeping it off the market. Another issue often discussed by traders is the reduced head count at Wall Street’s primary dealers.
“I think what Jamie was actually addressing was not the quantitative easing question. I think it was questions around liquidity in markets, and I do think that does need to be a preoccupation of regulatory authorities, and I think there’s a danger that in their enthusiasm for keeping each individual institution safe that regulatory authorities will lose sight of keeping markets open and liquid, and I think that is a legitimate concern that is raised,” Summers said.
Dimon pointed to the rapid 40-basis-point move in the Treasury market Oct. 15 as an illustration of the problem. He described the event as “unprecedented” and the type of “event that is supposed to happen only once in every 3 billion years or so” though he noted the event was easily absorbed by the market.
“I thought regulatory authorities made a mistake when they looked at each institution, and said, ‘You’ll be safer if you withdraw from the markets a bit,’ and then forget that if all institutions withdraw from the markets a bit, the markets would be less liquid. The markets themselves would be less safe. That would, in the end, hurt all institutions,” Summers said.
“I think there is a real issue there. Frankly, a lot of the effort that’s going into macro prudential should be into making sure we have liquidity,” Summers said.
In response to Dimon’s comment on a 3 billion year event, he said that remark said to him that the CEO was looking at some model for judging tail risk that wasn’t any good.
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Dimon said the liquidity issue has not been tested when markets are under duress.
“The banking system is far safer than it has been in the past, but we need to be mindful of the consequences of the myriad new regulations and current monetary policy on the money markets and liquidity in the marketplace—particularly if we enter a highly stressed environment,” Dimon wrote in his annual letter.
He also said it seems to be problem for foreign exchange. “Some currencies recently have had similar large moves. Importantly, Treasuries and major country currencies are considered the most standardized and liquid financial instruments in the world,” Dimon said.