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Federal Reserve Heavy Tackles Repo Market, Again

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Although things have been quieter on that front lately, the swell of voices in favor of breaking up the big banks is beginning to rise again. Recently, Federal Reserve Governor Daniel Tarullo added his opinion, speaking at the University of Pennsylvania Law School.  

Tarullo speech is important not only because his opinion carries so much weight, but because he gets to the heart of why banks need extra scrutiny post-crash: The lack of controls on the repo market, where many banks get their funding for trading and other banking activities -- and the root cause of the 2007 failure of the banking system.

A necessary evil, but one that can be controlled
Tarullo acknowledged that the bulking up of JPMorgan Chase (NYSE: JPM  ) , Bank of America (NYSE: BAC  ) , and Wells Fargo (NYSE: WFC  ) was encouraged by the government during the crisis, as those institutions were healthy enough to absorb failing entities such as Bear Stearns, Washington Mutual, and Wachovia. He noted that the overall effect was that of adding more weight to an already top-heavy banking model, but he did not advocate splitting the commercial side of these banks from the investment side, as some have done. His arrow was pointed more toward the shadow banking system, which makes up the bulk of short-term overnight borrowing in which the megabanks all participate.

This is not the first time Tarullo has put forth his suggestions for reining in the repo market. This past June, he outlined steps he felt should be taken by the Securities and Exchange Commission to improve the safety of the money market fund system, including capital requirements, flexibility on investor guarantees, and a less-rigid net asset value. Although all of these rules would help prevent another run on the repo market similar to the one that began in 2007, these changes were not supported by a majority of the SEC, which considered all these aspects this past summer, and so were not implemented.

Since that regulatory non-starter, Treasury Secretary Timothy Geithner has been pressuring for more money market reforms. The newly formed Financial Stability Oversight Council, created under Dodd-Frank, may be charged with taking a look at the repo sector, in addition to other financial oversight duties.

Since Tarullo's speech, former FDIC Chair Sheila Bair has chimed in, noting, as the Governor did, that the SEC should be promulgating rules to contain the $2.5 trillion repo market.

Fool's take
Protecting the financial system from another crash is multi-faceted, but has its roots in the money market mutual fund industry. Tarullo's speech was especially important not just because it directly addressed this situation -- while noting the SEC's failure in this regard -- but because it will help keep the pressure on this issue and prompt other financial heavy-hitters to keep the conversation going. Of all the changes that need to be made to keep the banking system safe, corralling the MMMF business is the most relevant, and must not be allowed to wither on the regulatory vine.

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Fool contributor Amanda Alix has no positions in the stocks mentioned above. The Motley Fool owns shares of Bank of America, JPMorgan Chase, and Wells Fargo. Motley Fool newsletter services recommend Wells Fargo. Try any of our Foolish newsletter services free for 30 days.

We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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