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IPFS News Link • Economy - Economics USA

Some preliminary financial stability lessons from the COVID-19 shock: Part 1

•, By Governor Lael Brainard

It has now been one year since the devastating effects of the first wave of the COVID-19 pandemic hit our shores, a year marked by heartbreak and hardship. We look forward to a brighter time ahead, when vaccinations are widespread, the recovery is broad-based and inclusive, and the economy fully springs back to life. But we should not miss the opportunity to distill lessons from the COVID shock and institute reforms so our system is more resilient and better able to withstand a variety of possible shocks in the future, including those emanating from outside the financial system.

The dash for cash

Investor sentiment shifted dramatically in the early days of March 2020 with the realization that COVID would disrupt the entire global economy. Short-term funding markets became severely stressed as market participants reacted to the advent of this low-probability catastrophic event. The abrupt repositioning and repricing of portfolios led to a dash for cash, as even relatively safe Treasury holdings were liquidated, volatility spiked, and spreads in Treasury and offshore dollar funding markets widened sharply. Forceful and timely action by the Federal Reserve and other financial authorities was vital to stabilize markets and restore orderly market functioning.

Although some parts of the financial system that had undergone significant reform in the wake of the Global Financial Crisis remained resilient, the COVID stress test highlighted significant financial vulnerabilities that suggest an agenda for further financial reform. I will briefly comment on these areas of vulnerability as well as areas where earlier reforms led to greater resilience.

Short-Term funding market vulnerabilities

The COVID shock brought to the fore important vulnerabilities in the systemically important short-term funding markets that had previously surfaced in the Global Financial Crisis.

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