20th Annual Financial Markets Conference: Central Banking in the Shadows: Monetary Policy and Financial Stability Postcrisis - March 30–April 1, 2015

Evergreen Hotel and Conference Center
Stone Mountain, GA


The Federal Reserve Bank of Atlanta recently assembled 150 leading practitioners and policymakers for discussions on the role of large nonbank financial firms, also known as shadow banks, in the nation's financial system and economy.

The 20th annual Financial Markets Conference featured celebrated speakers and panelists, including several top-level Fed officials and a former U.S. Treasury secretary. Speakers shared various perspectives on the Fed's monetary policy actions—which earned both praise and criticism—and on broad regulation of financial firms that are not traditional commercial banks. One common theme: sound, well-thought-out regulation is necessary, but there can be unintended consequences.

The conference is the Atlanta Fed's premier annual policy and research event. Gathering some of the world's influential minds in finance and economics helps the Atlanta Fed advance important conversations in finance and monetary policy. In addition, a lively exchange of views deepens the regional Reserve Bank researchers' and leaders' understanding of the complex interactions of Fed policy and financial markets.

Perspectives vary on wider regulation
One of the core questions the conference explored was whether traditional banks will remain central to the financial system. For now, evidence suggests that banks are still crucial, said former Fed Governor and University of Chicago professor Randall Kroszner. But technological innovation and regulation will largely determine whether commercial banks remain essential, Kroszner concluded.

Several speakers noted that extending regulation to institutions that traditionally have been lightly or not regulated is no panacea. Those speakers noted that in response to tighter supervision, risks will move to new unregulated "shadows." A few experts commented that rather than regulating nonbank institutions such as hedge funds, private equity firms, and mutual funds, regulation can better be applied to shadow bank activities and markets, regardless of the type of institutions that participate in them.

Nonbank sector particularly key in the United States
In his opening keynote address, Fed Vice Chairman Stanley Fischer explained that the nonbank financial sector in the United States is bigger and more important than in most countries. The nonbank sector has produced benefits such as increased market liquidity and a greater variety of funding sources. According to the International Monetary Fund, as of 2014 nonbanks perform 50 percent of the total lending in the United States. "However," Fischer said, "threats to the stability of the overall financial system have also increased, as was evident in the recent financial crisis." The crisis could be characterized as a run on the shadow banking system. When subprime credit collapsed, the asset-backed commercial paper market dried up and with it, a critical source of funding for a variety of shadow banking activities. The whole system suffered as a result of distress in one segment.

One panelist, MIT Professor Simon Johnson, pointed out that it is difficult even to cleanly separate banks from nonbanks. For example, Citigroup, generally considered a commercial banking firm, also ran one of the biggest nonbank operations in the world, he pointed out. "It's the interactions between banks and nonbanks that have caused a lot of trouble," Johnson said.

Another panelist, Mark Flannery, the chief economist at the U.S. Securities and Exchange Commission, said the larger economy is what matters most. In particular, he observed that in devising and evaluating financial regulations, it is important to consider the effect of the regulation on the macroeconomy, not just on individual financial companies.

Would more focus on stability further complicate things?
One panel focused on the degree to which central banks should focus on financial stability. Martin Hellwig of the German-based Max Planck Institute for Research on Collective Goods noted that financial stability has long been a concern of central banks around the world.

Nonetheless, David Zervos, chief market strategist for the investment bank Jefferies LLC, commented that crafting U.S. monetary policy is hard enough as it is. Giving the Fed another major responsibility such as financial stability, Zervos said, would only increase the potential for damaging mistakes in formulating policy.

Dodd-Frank imperfect but better than some alternatives
Regarding the Dodd-Frank Act, panelists generally agreed that it is imperfect. But Charles Goodhart, emeritus professor of banking and finance at the London School of Economics, pointed out that Dodd-Frank has worked better than European attempts at banking reform. That is one reason the United States has experienced a stronger economic recovery than has Europe, Goodhart added.

In the conference's final session, Atlanta Fed President Dennis Lockhart chaired a panel that explored the new role for some shadow banks—money market mutual funds, in particular—in the way the Fed transmits monetary policy into the financial system. Much of that discussion centered on the increase in the Fed's securities holdings during and after the financial crisis, and how the central bank should go about controlling short-term interest rates with such a large balance sheet. Lockhart noted that the $4 trillion-plus on the Fed's balance sheet creates unprecedented circumstances for conducting monetary policy.