Thanks to unprecedented interventions by central banks and fiscal authorities, the pandemic-induced financial strains of March-April 2020 are now well behind us. Unfortunately, as a consequence of the official actions necessary to stabilize the financial system, market participants now count on government backstops to insure them against the fallout from future disturbances.

Naturally, central banks should be prepared to combat extreme shocks that threaten financial stability. However, to limit excessive reliance on central banks, we need to ensure that financial institutions can continue to operate smoothly on their own even in bad times. This means redesigning parts of the financial architecture. While market participants have a major role to play, it is authorities who need to address externalities—spillover effects—and to improve incentives for the private sector to maintain the liquidity of markets and access to short-term funding in times of moderate stress.

With the pandemic-induced disruptions still fresh in memory, this is the perfect time to identify deficiencies and implement reforms aimed at improving the resilience of the financial system. Fortunately, the June 2021 Report of the Hutchins Center-Chicago Booth Task Force on Financial Stability (H-B) addresses all the key challenges, laying out a broad agenda for U.S. financial reform. In addition, we have the July 2021 G-30 Report that provides detailed proposals for reforming the U.S. Treasury market.

In this post, we discuss these reform proposals, highlighting areas where we strongly agree and believe that implementation is urgent. In particular, we emphasize the benefits that would come from changes in the Treasury market (cash and repo), in the central counterparties (CCPs) that have become the most critical links in the global financial system, and in open-end mutual funds holding illiquid assets. We also highlight the governance proposals in the H-B Report. In our view, full implementation of the agendas set out in the these reports would make the U.S. financial system far safer than it is today….