* Could expand central bank backstop to non-banks, he says
* Could also adopt laws that dissuade short-term funding
* Policymaker sees gradual improvement in global economy
By Jonathan Spicer
NEW YORK, Feb 1 An influential Federal Reserve
official on Friday suggested an even broader revamping of the
worrisome U.S. wholesale funding market than is currently being
New York Fed President William Dudley advocated expanding
the central bank's backstop to firms doing "socially useful"
business or forcing them to rely more on longer-term funding.
Dudley warned that extensive activity in the money markets
and tri-party repo markets takes place without proper safeguards
against runs and fire sales, and he urged U.S. lawmakers to take
a closer look.
Without endorsing a particular path, he suggested the
government could decide to extend access to the Fed's so-called
discount window to non-banks, while at the same time bulking up
supervision of those firms.
Alternatively, he said, laws could dissuade banks from using
short-term wholesale funding.
Dudley, a close ally of Fed Chairman Ben Bernanke, did not
comment on monetary policy in his breakfast speech to the New
York Bankers Association. Though he noted that improvements on
Europe, China and Japan was proof that the global economy is
The policymaker's comments on money markets and triparty
repurchase agreements, however, could shake up a regulatory
debate that has inched forward since the 2007-2009 financial
crisis exposed deep flaws in the so-called wholesale system.
"The status quo - where we are today - should be
unacceptable because we're sitting here with a latent risk,"
Dudley said in response to a question from a community banker.
If the Fed's emergency source of liquidity, known as the
discount window, is expanded to more firms, those firms would
have to pay for the benefit of the U.S. central bank's implicit
backstop, he added. That would likely involve a higher interest
rate and more Fed supervision.
"Regardless of where we come out on these questions, we must
make the basic structure of the wholesale funding market as
sound as possible," Dudley said at the landmark Waldorf Astoria
hotel in Manhattan.
Both the triparty and money markets have been under
regulators' microscope, though few big changes have been made.
The $2.6-trillion money market mutual fund industry
threatened to freeze global markets in the crisis, capped by
investors' rush to flee the well-known Reserve Primary Fund in
the fall of 2008 because of its heavy holdings in the collapsed
Lehman Brothers. The fund was unable to maintain its $1 per
share value, known as "breaking the buck."
The industry and the Financial Stability Oversight Council,
which includes officials from the central bank and the
Securities and Exchange Commission, have been locked in debate
over what changes to make since a sweeping SEC rule proposal was
blocked last summer.
Also last summer, the New York Fed unveiled reforms for the
$1.8 trillion U.S. triparty repurchase agreement market that
would force banks to reduce their reliance on the short-term
So-called repos are a prime source of short-term bank
funding and are backed by Treasuries or riskier collateral,
including mortgage-backed debt.
Dudley said that even after the reforms that are being
considered, the sheer size of the banking business that takes
place outside commercial banking entities - those with access to
the Fed's discount window - suggests the issue must not be
"We need to consider whether our current architecture is
satisfactory," Dudley said. If not, regulators could require
that longer-term debt fund the wholesale market, or laws could
be adopted to reduce the volume of activity in the market.
Dudley noted that a recent proposal by colleague Daniel
Tarullo, a Fed governor, to cap banks' size could achieve that
Alternatively, he said, any expansion of the Fed's "lender
of last resort" privilege to nonbanks would require legislation
that also expanded oversight. "Many thorny issues would have to
be resolved," he added.
GRADUAL IMPROVEMENT IN GLOBAL ECONOMY
Turning to the economic situation, Dudley, who has a
permanent vote on Fed policy, said the world is better now than
it was six years ago.
The euro zone's smaller economies are on better footing,
China's economic growth is accelerating, and the Japanese
government's fresh push to battle deflation, Dudley said.
"Things aren't perfect. But things are definitely improving,
and that will actually be helpful for the U.S. outlook," he
"If the rest of the world gets healthier, the demand for
U.S. goods and services will increase and that will provide
support to our own economy."
Dudley has consistently supported the Fed's unprecedented
policy efforts, including rock-bottom interest rates and some
$2.5 trillion in bond purchases, to support the slow U.S.
recovery from recession over the last few years.