On June 29, 2012, Boston Fed President Eric Rosengren spoke about whether US financial structures are prepared for financial instabilities. Rosengren discussed the social costs of financial structures having inadequate capital, saying:
Holding little or no capital for risky activities can, during good times, generate significant profits; even in relatively low-margin businesses. However, during times of stress, the power of leverage works in reverse, amplifying the negative impact of risky activities and necessitating substantial capital and liquidity at a time when both are in short supply.
Rosengren expressed concern about financial structures that, in his mind, may be "capital efficient" from the perspective of market participants, but may be vulnerable during times of financial market stress. He suggested that stress tests could be used to identify possible capital and liquidity demands of undercapitalized financial structures.
An example of an undercapitalized financial structure is, in his opinion, money market funds, which hold no capital. Rosengren reiterated his strong support for the SEC to implement reforms on all money market funds. Failing that, he suggested that banks with money market funds could include "likely money market mutual fund support in the sponsor's stress tests." In this manner, the bank sponsors of money market funds "could calculate the likely capital support needed from the organization in a stress scenario."
While admitting that this would be a piece-meal approach to the issue of money market fund reform, and less desirable than comprehensive reform adopted by the SEC, Rosengren expressed hope that the approach would both make banking organizations more resilient and "make clearer to money market mutual fund investors that banks had capital that could support funds during stressful periods."
The full text of the address can be found here.