Date
19 January 2017
In 2008, desperate investors tried to void ties to Lehman after it sought bankruptcy protection, helping to spread panic in global financial markets. Photo: Forbes
In 2008, desperate investors tried to void ties to Lehman after it sought bankruptcy protection, helping to spread panic in global financial markets. Photo: Forbes

Fed wants to shield failed banks from hedge funds during crisis

A new proposal by the Federal Reserve seeks to give big US banks greater protection from hedge funds in a future financial crisis.

It requires that some investors wait 48 hours before cutting ties with failing lenders, Reuters reports.

The two-day pause is meant to prevent a chaotic unraveling of investments as happened during the 2008 financial crisis and the collapse of Lehman Brothers Holdings Inc.

At the time, desperate investors tried to void ties to Lehman after it sought bankruptcy protection, helping to spread panic in global financial markets.

The scene of derivatives investors desperate to unwind contracts could spur a modern-day run on a bank, leading to  led to “asset fire sales that may consume many firms,” Federal Reserve chairman Janet Yellen said.

The proposal envisions a cooling-off period that could give banks time to transfer securities like derivatives to a healthy bank before bankruptcy, Yellen said.

Derivatives investors would have to acknowledge the 48-hour cooling off period in new financial contracts, according to the proposal, and existing contracts would also have to comply with the rule if the investment fund and bank continue to do business.

The Managed Funds Association, a voice for the hedge fund industry, expressed misgivings about the proposal.

“We … remain concerned that reducing investors’ rights under the US Bankruptcy Code would ultimately reverse decades of precedent designed to protect investors and the financial system, and would impair the fair and efficient functioning of capital markets,” the association’s chief executive officer, Richard H. Baker, said in a statement.

He said the group looked forward to continuing its dialogue with Federal Reserve officials.

Wall Street has until Aug. 5 to comment on the plan.

The new rule was envisioned as part of the Dodd Frank reform legislation and has backing from the Financial Stability Board, a global standard-setting panel for financial markets.

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