The Treasury Department’s Financial Stability Oversight Council (FSOC) met for 20 minutes this week and approved the issuance of a proposal for comment providing for the consideration of three options to strengthen the regulation of money market mutual funds (MMMFs), as well as a threat to declare one of more funds systemic and subject to heightened supervision under the Dodd-Frank Act.
This issue came before the Council because industry opposition has prevented Securities and Exchange Commission (SEC) Chairwoman Mary Schapiro from mustering a majority even to propose her draft regulations for comment. No one spoke explicitly against the proposal at this meeting, but Commodity Futures Trading Commission Chairman Gary Gensler urged that a “balance” be found that would not unduly jeopardize the viability of the money fund product.
At a Senate Banking Committee hearing on this issue, senators supporting the industry denied that runs are a problem with MMMFs, and the industry can be expected to continue to resist the proposal and to claim that the regulators are posing a threat to the ability of corporations and municipalities to fund themselves efficiently.
Treasury Secretary Tim Geithner began the meeting with an announcement that the central item on the agenda was a proposal for reform of MMMFs. He credited Schapiro for recognizing the need for such reform, and he called MMMFs essential to the financial stability of the United States.
Geithner recalled that in 2008, “some basic vulnerabilities in the design of MMMFs helped accelerate and exacerbate the financial crisis of 2008-2009,” yet reforms have not been put in place “to provide a sufficient degree of comfort against those basic vulnerabilities.”
He noted steps the SEC had taken in 2010, but they did not go far enough. Therefore, in August Schapiro announced that the SEC “did not have the basis to proceed yet with a vote” to put out for comment a set of additional reforms. In response to that, and on Schapiro’s recommendation, the FSOC has considered reforms that it might propose for comment as the next stage of reforms. Geithner said he hopes the SEC will move forward if there is a majority.
Geithner then listed the recommendations that will be proposed for 60-day comment:
• To require a floating net asset value (NAV), meaning that MMMF shares would not be fixed at $1.
• Require MMMFs to have a buffer of capital of up to 1 percent, in order to absorb losses, combined with a requirement that a small percentage of shareholder funds could be redeemed only on a delayed basis.
• Require MMMFs to maintain a buffer of capital of 3 percent to absorb losses, combined with a set of other measures that could reduce the size of the required buffer if deemed sufficiently strong to complement the buffer and reduce the vulnerability of the funds.
He referred to the first two items as “options” that were the focus of the SEC’s earlier consideration of reforms. Geithner also recognized that a range of other proposals has been suggested by the industry and by academics, and he said the FSOC would like to receive comments on those options as well to help the Council and the SEC consider how best to proceed. He reiterated that he hopes the SEC will “take this back and propose on its own a set of options for moving forward.”
Geithner then threatened “to use the designation process” and to work with other financial regulators to consider “alternative ways of trying to protect the financial system of the U.S. from the risks and vulnerabilities that still remain in money market funds.”
Schapiro said that she had asked several weeks ago “that the Council address the structural weaknesses that make money market funds susceptible to devastating runs” that are not just theoretical possibilities. She expressed satisfaction that the Council is taking action to protect investors, taxpayers and the financial system.
She referred to the first option up for comment as one that will enable the NAV to reflect the true underlying mark-to-market value of the fund, “like every other mutual fund,” and she referred to the events of 2008 as “a broad-based run on prime money market funds” that happened in a matter of days and “exacerbated strains in the short-term credit markets, panicked money market fund investors and sharply reduced short-term funding for American corporations and municipalities.”
She lamented that there was no FSOC at the time “tasked with searching for risks that could cascade throughout the financial system and harm our economy.” Schapiro proclaimed that the FSOC and SEC are “jointly committed to making the tough calls required” to avoid another financial collapse. She added that the 2008 run abated only after federal intervention by the Treasury and Federal Reserve.
She went on to endorse the floating NAV as “the pure option, the simplest option and the option that is most consistent with the SEC’s regulatory approach to investment products.” At the same time, she acknowledged “that investors value a stable NAV product” and said she is open to options that would enable a stable NAV with additional structural protections to absorb losses and discourage runs. Schapiro warned that institutional investors are quick to run at the first sign of trouble, so that retail investors bear the brunt of losses.
She joined Geithner is expressing the hope that the SEC will act, so that the FSOC will not have to proceed “to address one of the key leftover issues from the financial crisis.”
Federal Reserve Chairman Ben Bernanke then spoke in favor of the proposal and stated that in 2008, $300 billion of redemptions took place in just five days and disrupted credit flows, even though it only involved one fund. These runs were stopped by federal interventions using powers that he pointedly asserted are “no longer available.”
He elaborated on the vulnerabilities of MMMFs, which he said “promise a fixed, stable share price of $1, even though they have credit risk and incomplete or limited funding liquidity.” Bernanke called the 2010 reforms a very useful first step, because they did not address the NAV issue and the incentive for first movers to propagate a run even before losses are revealed.
Bernanke mentioned another run of $180 billion in 2011 over eight weeks, in response to concerns about the exposure of MMMFs to European banks, even though the buck was not broken. Since the basic run problem has not been solved, the FSOC cited this issue as a source of systemic risk in its most recent annual report. Bernanke concluded that he hopes the SEC will take action on the proposal.
Gensler spoke next and advocated finding an appropriate balance between dealing with the run risk, “the bear in the woods” and the risk of “changing the product that so many Americans rely upon.” The slowest campers remain at the highest risk, he stated.
Robert Feinberg served on the staff of the House Banking Committee for the 10 years that encompassed the savings-and-loan debacle and the beginning of its migration to the banking sector. Subsequently, he has consulted on issues related to the crisis for law firms, accounting firms, securities firms and trade associations.
Feinberg holds a BS.E. from the Wharton School and a J.D. from the Law School of the University of Pennsylvania. He has drafted dissenting views on landmark banking legislation, contributed to a financial blog and written hundreds of reports for clients to document the course of the financial crisis as it has unfolded over the past three decades.
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