The Dodd–Frank bill passed in 2010 in the immediate aftermath of the financial crisis, in which the major commercial and investment banks were ground zero. The banks were the major lenders and mortgage originators in the housing crisis; their balance sheets were riddled with the toxic assets; they were each other’s counter parties in a slew of transactions; and the capital holes on their balance sheets were the source of the financial system’s misery. Policy prescriptions (TARP, and the Fed’s endeavors) were largely driven by the need to plug those banks’ capital holes. Post-crisis legislative efforts were allegedly driven by the need to better regulate those entities (the final result was not exactly on target).

The COVID market swoon of March was pandemic-driven, and it’s harder to find a culprit to blame for that. That said, there are increasing calls for some Fed or policy response to deal with so-called “non-bank lenders.” Whether it is hedge funds, money market funds, or non-bank lenders (mortgage servicers), there are a host of non-traditional financial actors who are clearly becoming targets for increased regulation. As is almost always the case, the various bumps and bruises that took place in March involving the different categories of financial actor listed above have no relation to one another, yet are now being all stirred together into one (unhelpful) conversation.

I expect the Fed to be the ultimate arbiter as to where the problems may be (or not) in shadow finance, and I expect the Fed will conclude that non-traditional liquidity providers are an important part of our financial ecosystem. That said, our financial system is leveraged, it always has been, and it always will be. Therefore, in moments of peak distress, we will see what we saw in March again — the exacerbation of distress — no matter what any regulator says or does.

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