Regulating Money Creation After the Crisis

Abstract

Like bank deposits, money market instruments function in important ways as "money." Yet our financial regulatory regime does not take this proposition seriously. The (non-government) issuers of money market instruments-almost all of which are financial firms, not commercial or industrial ones-perform an invaluable economic function. Like depository banks, they channel economic agents' transaction reserves into the capital markets. These firms thereby reduce borrowing costs and expand credit availability. However, this activity- "maturity transformation "-presents a problem. When these issuers default on their money market obligations, they generate adverse monetary consequences. This circumstance amounts to a market failure, creating a prima facie case for government intervention. This Article evaluates policy alternatives in this area. It finds reasons to favor establishing money creation as a sovereign responsibility by means of a public-private partnership system-in effect, recognizing money creation as a public good. (This is just what modern bank regulation has done for decades.) Logically, this approach would entail disallowing access to money market financing by firms not meeting the applicable regulatory criteria-just as firms not licensed as banks are legally prohibited from issuing deposit liabilities. Against this backdrop, the Article reviews the Dodd-Frank Act's approach to regulating money creation. It finds reasons to doubt that the new law will be conducive to stable conditions in the money market.