Breakingviews - March’s market bailout demands regulatory payback

LONDON - After the panic comes the bailout. And after the bailout comes the reckoning. In 2008, governments rescued banks and then embarked on a decade-long overhaul to ensure they would never need to do so again. This year’s pandemic-induced meltdown in financial markets, which prompted similarly unprecedented interventions, has sparked a comparable backlash.

Bank reforms were partly responsible for the market ructions this time round. After 2008, regulators explicitly set out to shift risks, such as proprietary bets on property or commodities, from bank balance sheets to investment funds better suited to coping with asset gyrations. They succeeded.

These interventions were, as the FSB noted last week, “speedy, sizeable and sweeping”. They were also effective: with the help of large-scale government spending, markets quickly rebounded. Yet the crisis still raises urgent questions for financial authorities. Malfunctioning markets impose extra costs on companies, consumers and governments. And if central banks make a habit of propping them up in a crisis, investors will be motivated to be more reckless in future.

Yet focusing on specific parts of the world’s financial plumbing risks missing the broader lesson, which is that markets magnified the economic shock of Covid-19. For example, consider hedge funds which arbitrage price differences between U.S. Treasury bonds and futures contracts. In normal times this activity appears to improve the market. But in March, as investors sold Treasuries to raise cash, hedge funds joined the rush for the exit.

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March’s market bailout demands regulatory paybackCentral banks were right to prop up financial markets when the pandemic caused panic. But their support exposed structural flaws and may lead to future recklessness. Preventing that requires regulators to extend their reach. Compared to 2008, the reforms are less obvious.
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