Tags: capital | money market | funds | proposals

House Financial Services Defends Money Funds — Part I

By    |   Thursday, 03 Oct 2013 02:25 PM

The House Financial Services Committee's Subcommittee on Capital Markets and Government Sponsored Entities, chaired by Scott Garrett, R-N.J., held a hearing Sept. 18 on a controversial proposal by the Securities and Exchange Commission (SEC) to augment regulations it adopted in 2010 to strengthen money market mutual funds (MMMFs) against destructive runs of the kind that contributed to the 2008 episode of the ongoing financial crisis that threatened the U.S. and global financial system.

Two articles will be devoted to this issue, because if there's one thing all parties agree on, it is that MMMFs are a very important financial product to investors, issuers and regulators, a point all sides in the debate try to use to their advantage.

However, in keeping with the strategy of the financial services industry lobbies to present the industry as the victim, rather than the cause, of the 2008 episode, Garrett, in his opening remarks, faulted the processeez of the SEC's consideration of the current proposal as representing "the good, the bad and the ugly of agency rulemaking."

In presenting this view, Garrett channeled Republican SEC Commissioner Dan Gallagher, who criticized former Chairman Mary Schapiro for presenting the regulations as "an inviolate fait accompli," already blessed by the other financial regulators, but without any input from the SEC's own commissioners and lacking in economic analysis. This last theme has been established as a favorite one of industry opponents of Dodd-Frank regulations since the D.C. Circuit threw out the SEC's proxy access rules as lacking sufficient a cost/benefit analysis.

Garrett also pointed to work by the House Oversight and Government Reform Committee, chaired by Darrell Issa, R-Calif., that then-Chairman Schapiro, the Financial Stability Oversight Council (FSOC) and the Federal Reserve developed the proposal and exerted "undue political influence" on the SEC to accept it.

In a shocking discovery, Issa's staff found that the SEC and the Fed drafted a letter for the FSOC to send back to the SEC demanding action on the money fund regulations. Garrett complained that after Schapiro could not muster a majority of the Commission to take up the rule, the FSOC "doubled down" on the SEC and demanded it consider specific reforms, including capital buffers, to improve the ability of funds to withstand times of stress, that Garrett found "an entirely inappropriate option for money market funds."

(Readers have learned that the financial services industry is allergic to any regulations that require firms to place actual capital behind the financial products they offer, because this reduces their return on equity.)

According to Garrett, one reason capital requirements are inappropriate is that "Money market funds are fundamentally a securities product, and I believe that consumers should think of them as such." (As a recovering lawyer myself, I understand that lawyers tend to think such artificial distinctions among financial products are more important than civilians do, but even lawyers should beware of, as the cliché goes, "exalting form over substance.")

Garrett went on, "Forcing money market funds to hold bank-like capital will only foster the false perception among many investors that these funds are more like, well, federally insured bank accounts than securities products."

However, this would not be the case if depositors had to consider how much capital banks actually hold, but since a federal guarantee, rather than a poorly funded deposit insurance scheme, stands behind the deposits, this is not a problem for bank customers, and banks are largely immune from market discipline.

Next, Garrett offered the somewhat contradictory argument that as the SEC staff has concluded, "The capital buffer contemplated in the original rule proposal would likely be insufficient to absorb very large losses on the level experienced during the financial crisis. A buffer high enough to do so would be, well, impractical." This is like saying the food in this restaurant is awful, and the portions are so small.

Finally, as presented by Garrett and Gallagher, the third argument is that the only purpose of a capital buffer would be as "the price of entry into an emergency lending facility at the Fed that they could construct during any future crisis. In short, the buffer would provide additional collateral to provide a Fed bailout to the troubled funds."

Garrett concluded that after all the other government bailouts, costing billions of dollars, "we simply can't afford to extend another taxpayer-funded bailout, and the moral hazard that goes with it, to money market funds."

Garrett is right that taxpayers can't afford the bailouts; that's why a capital buffer should be extracted from the industry, and if this makes the product "impractical," a lesson to be learned from the 2008 episode is to require financial firms to bear the full costs of managing the risks their products pose to the larger financial system, and the FSOC has identified money market funds as a product that poses such risk.

Having enthusiastically bashed the earlier proposal that money funds should be required to hold capital, Garrett turned to the latest version proposed under current SEC Chairman Mary Jo White that sets forth three alternatives: 1) allow the net asset values (NAVs) of shares to "float" away from $1; 2) erect so-called "gates and fees" to discourage investors from running if they lose confidence in funds; and 3) a combination of the two measures.

Garrett expressed satisfaction that the latest proposal was informed by a study by the SEC's Division of Economic and Risk Analysis showing that institutional, rather than retail, shareholders were more likely to run in times of stress.

Garrett added that he was especially pleased that the current proposal "does not include a capital buffer or alternatives that enshrine taxpayer bailouts or make securities products look like bank products."

It is noteworthy that Garrett went on to make a philosophic argument against capital buffers: "I believe the decision to exclude a capital buffer from the SEC's current rule proposal is an important step in resisting the push to remove substantially all the risk from security products. This would ultimately hurt investors, by reducing their ability to generate much-needed returns on their investment and retirement dollars."

To me, this argument seems highly contrived and totally misses the point that the purpose of capital is to prevent financial services firms from foisting all of the risk of messy failures on investors.

Subcommittee Democrats generally supported the proposal, but raised questions about how it would work in practice. For example, the ranking Democrat, Carolyn Maloney of New York, who represents Wall Street, questioned whether, with so much attention focused on the floating NAV component, not enough attention would be paid to the question of whether investors could risk the possibility of having to go 30 days without access to their funds in times of stress.

Stephen Lynch, D-Mass., expressed concern that the attempt to distinguish institutional from retail customers might work to the detriment of municipalities that rely on the funds as a place to park short-term money.

It is interesting to observe that at this stage, for whatever reasons, these representatives from states where the securities industry is very influential are open to supporting the rule, at least for the time being.

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Robert-Feinberg
The House Financial Services Committee's Subcommittee on Capital Markets and Government Sponsored Entities held a hearing on a controversial proposal by the SEC to augment regulations it adopted in 2010 to strengthen money market mutual funds (MMMFs) against destructive runs.
capital,money market,funds,proposals
1188
2013-25-03
Thursday, 03 Oct 2013 02:25 PM
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