In a January 10th op-ed in the Wall Street Journal, billionaire asset manager Steve Schwarzman, head of the Blackstone, argues that financial regulators have gone too far in regulating markets since the 2007-2008 financial crisis, and that over-regulation could lead to a liquidity freeze and another financial crisis.
Schwarzman argues: “Despite good intentions, however, politicians and regulators constructed an expansive and untested regulatory framework that will have unintended consequences for liquidity in our financial system. Taken together, these regulatory changes may well fuel the next financial crisis as well as slow U.S. economic growth.”
Schwarzman slams the Volcker rule
The op-ed starts with a critique of the Volcker Rule that bans proprietary trading by banks. Schwarzman says that this ban, together with enhanced capital and liquidity requirements, has resulted in most banks avoiding some market-making functions in key equity and debt markets. This has led to a notable reduction in liquidity in the many markets, particularly debt markets.
He points to the “flash crash” last October in the U.S. Treasury market with huge intraday moves apparently not connected to external events as a warning sign. Deutsche Bank says that that dealer inventories of corporate bonds have shrunk by 90% since 2001, despite total outstanding corporate bonds increasing by nearly 100%. Schwarzman notes that a “liquidity drought can exacerbate, or even trigger, the next financial crisis. Sellers will offer securities, but there will be no buyers. Prices will drop sharply, causing large losses for investors, pension funds and financial institutions. Additional fire sales will aggravate the decline.”
Dodd-Frank Act hurting small businesses
Schwarzman continues to hammer the Dodd-Frank Act. He says that small business owners will be especially vulnerable in a liquidity freeze because the number of community banks dropped by 41% between 2007 and 2013. He points to studies by the Richmond Federal Reserve and Harvard University suggested that the 2010 Dodd-Frank Act contributed to this decline in community banks. The application of Dodd-Frank to community banks should be reconsidered in Schwarzman’s view, given these institutions’ special relationship with borrowers in agriculture, small business and local real estate.
According to Schwarzman, a comprehensive rethinking of financial regulation is required to prevent another crisis. “Given the rapid expansion of bank regulation and growing liquidity concerns, regulators need to revisit whether they have overshot the mark. They need to assess the costs of liquidity regulation and take into account the perspective of consumers, businesses and other stakeholders who will depend upon access to the banking system in a crisis. This reassessment should explore countercyclical liquidity and capital strategies that encourage banks to support their customers in a crisis.”