There are still major vulnerabilities in the US financial system, especially in areas of "shadow banking", which are inadequately regulated-- and in the overhaul of the mortgage finance infrastructure. Too big to fail institutions that are of global systemic importance could still fail and have negative consequences for the entire financial system. And it may take 15 more years for banks to implement all the new capital requirements global regulators insist are required as protection against another crisis such as occurred in 2008.
This somewhat troubling scenario was presented today by Federal Reserve Board member Daniel Tarullo before a group gathered at the Council on Foreign Relations in New York. Tarullo made it abundantly clear that major reform programs are still mandatory in several key parts of the unregulated parts of the banking system despite the passage of the Dodd-Frank legislation in 2010.
Tarullo particularly called for additional reforms of the $2 trillion money market fund group like Fidelity, Putnam and T. Rowe Price-- where "the combination of fixed net asset value, the lack of loss absorption capacity, and the demonstrated propensity for institutional investors to run together" could trigger another crisis as occurred in 2008 when the safety of these short term funds were called into question.
Tarullo also singled out the concerns over the safety of the tri-party repo market, where trillions of dollars of intraday credit are extended by the clearing banks, JP Morgan Chase and Bank of New York-Mellon. One major operational problem centers on the use of collateral between two banks that might be reused or rehypothecated in a separate transaction involving yet another bank.
For example, both Goldman Sachs and JP Morgan disclose in footnotes to their balance sheet the use of over half a trillion dollars in collateral-- or a trillion just among these two giant institutions that is supposed to be securing swap arrangements. Tarullo claimed that proposals for "operational improvements to the tri-party market... fell short of dealing comprehensively with this problem."
The Fed member also warned that "there is not currently in place an effective system for funding well-underwritten mortgages. To return to, and maintain, a healthy housing market, we will need a healthy system of mortgage finance. A surprising admission that more than 4 years after the 2008 meltdown in real estate prices, the nation still does not have a stalwart system in effect to lend on residential property. No wonder potential home buyers have such difficulty in obtaining mortgages.
Summing up, Tarullo suggested it may be "several years before there can be full implementation of reforms" to the financial system.
