Big-bank rule may have fueled December’s stock market rout

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The Trump economy has been strong. Buoyed by major Republican-led initiatives, including historic tax cuts and regulatory relief, the economy has been growing at an annual 3% clip and job creation is booming.

That’s why many mainstream investors were shocked to see extreme financial market volatility at the end of 2018. For the full month of December, one of the broadest gauges of the U.S. stock market, the S&P 500, fell by 9%. This type of move should not be happening with the economic fundamentals we currently have.

Given that our economy appears to be in solid shape and corporate earnings are still growing, why all of a sudden was the equity market experiencing extreme 4% intraday swings? In addition, why were the fixed-income markets, particularly the interdealer repo market, also experiencing wild volatility?

As a member of the Senate Banking Committee, I think it is imperative that we find out an answer to this question. These types of market moves erode confidence in our system and make it less likely that hardworking Americans are willing to participate in buying stocks and bonds. This loss of trust will hurt retirement savings and also dry up capital going into our markets, which will lower long-run economic growth.

While I am committed to finding out the answer this Congress, several market experts have already pointed to a culprit: a misguided and cumbersome series of bank regulations implemented by the Federal Reserve, but designed by an international organization based in Basel, Switzerland. With a banal name and an ever-expanding mandate, the Financial Stability Board could be behind some of the volatility we have seen. Created at the 2009 G20 Summit in London, this board, along with other global bureaucrats, is charged with designating banks as “systemically important.” Banks on this list were made to abide by special rules and regulations, one of which is known as the G-SIB surcharge.

The G-SIB surcharge is calculated just once at the end of every year. The problem with the G-SIB surcharge comes with its inherent complexity and the way it is calculated. Using 12 indicators grouped into five categories that are each risk weighted, the score boils down many subjective risks to just one number.

While the expansion of algorithmic trading and the move toward electronic trading desks makes it difficult to discern the underlying reasons for market moves, I understand incentives. Banks were pulling back liquidity in December in order to decrease their surcharge. Combine this with the fact that during the holidays, especially after Christmas, many trading desks are thinly staffed, the potential for liquidity to be dramatically reduced in the equity and fixed-income markets becomes a real possibility.

This set of rules and its unintended consequences could be partly to blame for a lack of liquidity at the end of the year.

Although financial market volatility is driven by several factors, many of which are out of congressional control, the new 116th Congress, or perhaps the Federal Reserve using its “safety and soundness” authority, could do its part in reducing volatility by continuing to work on common-sense financial regulatory reform. I am committed to making the system safer, while at the same time more accessible.

Fixing the timing of this surcharge and enabling banks to provide liquidity when the market needs it are areas in which further oversight is needed to ensure the proper functioning of our world-class capital markets and continued economic growth and momentum.

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Capital requirements Risk-based capital GSIBs Policymaking Financial regulations FSB Federal Reserve