Looking through a glass onion: lessons from the 2022 LDI intervention − speech by Andrew Hauser
Given at the Initiative on Global Markets’ Workshop on Market Dysfunction, the University of Chicago Booth School of Business
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First, we need a clearer sense of how much market dysfunction societies are willing to tolerate – whether defined in terms of a certain spread around risk-free rates, a certain level of liquidity, or the absence of unstable firesale dynamics. And, we need a clearer sense of the extent to which this tolerance should be achieved through self-insurance by market participants (in particular non-banks) – with the residual presumptively falling to public authorities to backstop through tail risk insurance. Without clearer guide rails of this kind, we are destined to proceed somewhat messily from crisis to crisis, building a framework by circumstance rather than by design.
Second, we need to work towards a more developed understanding of the tools that central banks need to deal with this new era of liquidity risk, and in particular the right mix between lending and asset buy/sell facilities required in different scenarios. Most of us share the instinct that lending tools are the right place to start – but progress on defining the set of non-bank firms that are needed, able and appropriately incentivised to participate has so far been limited. And there are important debates to be had about the regulatory perimeter. Whether a steady state toolkit will require buy/sell tools is an important debate – but at the very least it does seem that we are going to need to be able to reach for ‘break glass’ versions of such tools until and if more developed repo facilities are developed.
Third, we need to debate the relative merits of standing vs discretionary facilities. Appropriately designed standing facilities could help reduce the incidence of future liquidity crises, by clarifying the circumstances in which public assistance would be available, replacing the sort of crude guesswork that constructive ambiguity can generate, and incentivising more effective self-insurance. But calibrating them accurately, and ensuring they are ready to function, requires sharply improved levels of understanding and operational readiness. Standing facilities that are calibrated either too vaguely to shape ex ante behaviours, or too specifically to be able to flex in response to events, are unlikely to be of lasting value.
The full speech is available at https://www.bankofengland.co.uk/speech/2023/march/andrew-hauser-opening-remarks-at-university-of-chicago-booth-school-of-business-workshop