Federal Reserve officials spoke out twice in the past month to send a signal to money-market funds resisting tighter U.S. regulation. The message: New rules are coming, one way or another.
The U.S. Securities and Exchange Commission has been deadlocked for months over proposed rules that would require the $2.5 trillion money-fund sector to float share prices or hold more capital, measures that could make funds less attractive to investors.
The comments were “an effort to tell the industry to work with the SEC because, ‘If they don’t get you, we can,’” said Karen Shaw Petrou, a managing partner at Federal Financial Analytics, a Washington research firm.
In a speech in the Netherlands, Rosengren said the Fed’s stress tests should be expanded to include money funds in their calculations.
“Based on the historical experience of their money-market funds, the historical experience of similar funds, and their money-market funds’ exposures, sponsors could calculate the likely capital support needed from the organization in a stress scenario,” he told the Conference on Post-Crisis Banking on June 29.
Rosengren’s comments followed remarks from Tarullo on June 12 supporting the SEC’s proposals. At the same time, he said regulators have other options if the SEC is unable to impose a rule.
“In the absence of such action, there are several second- best alternatives,” Tarullo said. One option is that bank “supervisors consider setting new limits on banks’ reliance on funding provided by money-market funds.”
The signals are not limited to the U.S. Paul Tucker, deputy governor of the Bank of England, has said European regulators might take similar action to limit their banks’ exposure to U.S. money funds if the SEC doesn’t act.
The SEC’s five commissioners have received a 337-page staff proposal that would offer funds a choice of either floating the share price or holding more capital. An SEC vote could come as soon as this month to proceed on the rule by asking for public input.
SEC Chairman Mary Schapiro and other regulators have repeatedly said that money-market funds are vulnerable to runs during times of crisis when investors rush to redeem shares. They cite the example of the $62.5 billion Reserve Primary Fund, which collapsed in September 2008, contributing to a system-wide credit freeze. The U.S. Treasury Department stepped in to guarantee the funds and stabilize the system.
In 2010, the SEC increased liquidity requirements for the funds as a stopgap measure to prevent further bailouts. All the same, money-market funds can and do lose money, forcing their sponsors to make up the difference. The biggest U.S. money funds are sponsored by Fidelity Investments, Vanguard Group Inc. and JPMorgan Chase & Co. (JPM), with assets of more than $100 billion each.
Schapiro told the Senate Banking Committee on June 22 that the agency has found at least 300 examples of money-fund sponsors stepping in to provide or line up capital support to prevent the funds’ share price from falling below the guaranteed $1, called “breaking the buck.” Three of those instances, she said, happened after the SEC imposed the 2010 liquidity rules.
There has been a “pattern of support” for mutual funds by the banks that sponsor them, “without an explicit recognition that such funds can be a capital drain” on the banks during times of stress, Rosengren said in his speech in Amsterdam.
Consumers and retail investors often confuse money-market funds with federally insured banking products, such as savings and checking accounts. Fed Chairman Ben S. Bernanke told the Senate Banking Committee in March that some investors turn to money funds “because they think they’re absolutely a hundred percent safe,” which is “not true.”
Bernanke and Treasury Secretary Timothy F. Geithner have also warned of risks posed by the banking sector’s reliance on short-term funding in the form of money-market cash and repurchase transactions. Money-market funding accounts for 1.6 percent of Bank of America Corp.’s short-term liabilities and 1.3 percent at JPMorgan, according to a June 22 report from Fitch Ratings.
The SEC proposal doesn’t have majority support on the five- member commission. The two Republican members, Troy Paredes and Daniel Gallagher, have joined with Luis Aguilar, a Democrat, in resisting the rules.
The Fed’s push could weaken opposition to regulation inside the SEC, said former agency Chairman Harvey Pitt, a Republican.
“If the Fed says we need rules, the SEC is going to be hard-pressed to say, ‘No we don’t,’” he said.
Industry groups who oppose the proposed rules contend that the SEC’s job is to monitor the markets, not regulate banks.
“If there’s a problem in the banking system that banks are too dependent on short-term financing, then obviously that’s something that should be addressed through bank regulation,” said Paul Schott Stevens, president of the Investment Company Institute, a Washington-based trade group.
Gallagher said that systemic risks on Wall Street shouldn’t be the SEC’s concern. In an interview, he said he wouldn’t object if the Fed, which has broader systemic risk responsibilities, chose to make it harder for banks to work with money funds.
“Governor Tarullo identified a path that banking regulators could take to remedy perceived problems with short- term funding markets, including the role played by money-market funds. Fed officials have also raised the idea of expanding stress tests to incorporate support for bank-sponsored money- market funds,” Gallagher said. “If the banking regulators feel they have the basis and need to take action in that space, then such action would be entirely appropriate.”
To contact the reporter on this story: Steven Sloan in Washington at firstname.lastname@example.org