August 24, 2012
What Securities and Exchange Commission Chair Mary Schapiro couldn’t say publicly, Arthur Levitt – one of her predecessors – could. Three of Schapiro’s fellow SEC commissioners have refused to go along with attempts to create tougher rules for the $2.6 trillion money market mutual fund industry, prompting Schapiro to halt the agency’s efforts for reform. Levitt bluntly called that development a “national disgrace.”
Levitt’s criticism notwithstanding, it’s fairly safe to say that Schapiro – who has a reputation of blending tough talk with the right combination of political lobbying and horse-trading to be more effective than many of her peers among Washington regulators – did whatever she could to sway the three dissenters. When that didn’t work, she reacted in a way that may yet make overhauling money markets politically contentious enough that the issue won’t just die quietly. She acknowledged defeat in a peculiarly public manner, issuing a statement that spelled out the failure, made clear her disgust with the length of time it has taken to reach an inconclusive conclusion, and punted the issue straight into the laps of policymakers who, she said “now have clarity that the SEC will not act to issue a money market fund reform proposal and can take this into account in deciding what steps should be taken to address this issue.”
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To some, the issue may seem arcane – but it matters. As Schapiro points out, it’s a piece of unfinished business left over from the financial crisis of four years ago, when the $62.5 billion Federal Reserve Primary Fund “broke the buck” – the market value of its assets fell below the $1 per share mark – and then collapsed. That destroyed what Schapiro refers to as a “false sense of security” that had endured in capital markets for decades before. A complete freezing of short-term credit issuance followed. Only temporary guarantees from the Federal Reserve and the Treasury Department saved the financial system from a prolonged and major crisis. “In short, every taxpayer in the nation found themselves a partial insurer of a $multi-trillion investment product,” Schapiro said in her statement.
If anything has changed, it is only for the worse, especially given the latest twist in the tale. As Schapiro points out, there’s no legal requirement that sponsors of money market funds support the $1 per share level, and in some cases, there may be no ability to do so. “We must be cognizant that the tools that were used to stop the run on money market funds in 2008 no longer exist,” Schapiro pointed out in her statement. “That is, there is no ‘back-up plan’ in place if we experience another run on money market funds because money market funds effectively are operating without a net.”
Some of the reservations that the three SEC commissioners have may well be valid. The two alternatives that the commission’s staffers had proposed – requiring money market funds to mark their assets to market like other funds, spelling out that there really is no guarantee of those assets remaining at or above $1, or requiring funds to set aside a capital buffer to reflect the amount of risk – certainly may have unintended consequences. Perhaps some investors would end up in unregulated products instead, as Democrat Luis Aguilar, the swing member of the commission, appears to fear, according to The Wall Street Journal.
But unintended consequences may be part of any regulation. They’re reason for study and debate, not an excuse for inaction. It’s up to regulators to make good-faith efforts to push forward initiatives of this kind and not just throw their arms up in the air.
Certainly, the proposed changes would have been grim for the asset management industry, already struggling to run money market funds at a profit in an era of historically miniscule short-term interest rates. Pile any more costs atop these funds, and the industry might as well be running them as a public service. But that is a problem for the businesses to resolve. The issue in front of regulators is how to make the entire financial system as stable as possible. As Schapiro noted in her statement, “the issue is too important to investors, to our economy and to taxpayers to put our head in the sand and wish it away. Money market funds' susceptibility to runs needs to be addressed.”
Investors rejoiced at the SEC’s failure, driving shares of money management firms like Federated Investors higher. But opponents of Schapiro’s reforms might want to be careful. The tone and nature of her comments have made the issue hard for politicians to ignore in an election year. Not that money market reform is going to emerge as a big political hot potato (although that certainly would make the nature of the political debate more meaty). But the years that have elapsed since 2008 haven’t left voters on either side of the aisle any less bitter about the crisis; on both sides, there is plenty of ire about bailouts and bankers appearing to ride off into the sunset in their Lamborghinis while ordinary folks lose their homes and struggle to stay afloat. Plenty of voters and activists remain eager to jump on anything that looks like Wall Street conspiring to stall reforms.
In this case, at least, former Goldman Sachs officials who have been in the crosshairs before, like New York Fed President William Dudley, are on Schapiro’s side of the debate, supporting the reforms. Aguilar, however, is likely to endure a roasting, given his former job as counsel for a big mutual fund complex, Invesco. On the one hand, that position certainly gave him a deep knowledge of how such cash-proxy funds function and the real risks associated with regulating them. But the optics aren’t good.
So the question won’t be whether money market funds are to be regulated more intensively, but who is going to write those new rules, how attuned to the industry they are and how effective they will be. The SEC commissioners may well find themselves regretting that they have cleared the way for the Financial Stability Oversight Council, an agency created by the Dodd-Frank Act, to step in and either compel the SEC to act or put the whole matter in the hands of the Federal Reserve.
Admittedly, this path is untested – the FSOC is a fledgling body that hasn’t yet had to try to wield its power in the wacky world of Washington. Still, it’s hard to imagine that the FSOC wouldn’t consider the money funds industry to be systemically important – its size and the events of 2008 argue against that – and it’s hard to imagine that any rival package of reforms wouldn’t include many elements of the SEC plan. Other measures proposed might actually turn out to be still clumsier or more costly for the industry.
The asset management industry and the SEC commissioners who oppose money market reforms have gambled heavily – and won on one throw of the dice. But they can’t pull their cash off the table and go home. The game must continue. They may be counting on Washington’s legendary inaction, or the unwillingness or inability of infuriated individuals like Levitt to whip up outrage in the public or in the White House. But that’s a risky bet – almost as risky as leaving money market funds to putter along as they are today, a source of systemic risk.