Money-market mutual funds, an alternative to bank accounts for individuals and companies, will test the resolve of the U.S. Federal Reserve and Treasury Department to prevent another financial crisis after the $2.6 trillion industry successfully lobbied against more regulation by the Securities and Exchange Commission.
Fed Governor Daniel Tarullo has said the central bank could tighten rules on banks’ borrowing from money-market funds, and Boston Fed President Eric Rosengren has said officials have the option to force banks to back their money funds with capital. The Fed and the Treasury could also work through the Financial Stability Oversight Council, a new regulatory panel formed under the Dodd-Frank Act, to seize oversight of money funds from the SEC and grant that power to the Fed.
“There’s real unanimity in the bank regulatory arena about the need to do something about money-market funds,” Karen Shaw Petrou, managing partner of Washington-based Federal Financial Analytics Inc., said in an interview. “What the Fed can do, and I think will try to, is put the funds back in a much more limited corner, by isolating them from integration with the banking sector.”
SEC Chairman Mary Schapiro this week abandoned a four-year effort to adopt tougher rules for money funds as three fellow commissioners said they wouldn’t support her proposal. The announcement marks a victory for the fund industry, which had lobbied against the plan.
Former SEC Chairman Arthur Levitt called the decision by three commissioners to block Schapiro’s proposal a “national disgrace” and said the Obama administration should pursue the issue through the Financial Stability Oversight Council, or FSOC, the panel Congress charged under Dodd-Frank with monitoring the country’s financial threats.
“This is an important time for the President to weigh in” and for the Fed and Treasury to make “changes in how the system works,” Levitt said in an interview on Bloomberg Television.
FSOC is headed by Timothy F. Geithner, the Secretary of the Treasury. Other voting members include Fed Chairman Ben S. Bernanke, Schapiro, and heads of the Federal Deposit Insurance Corp., the Commodity Futures Trading Commission and the Comptroller of the Currency.
The Treasury Department is consulting with the Fed, SEC and other regulators “to consider the appropriate next steps to reduce risks to financial stability from money-market funds,” according to an e-mailed statement yesterday from Suzanne Elio, a Treasury spokeswoman.
FSOC faces technical and political hurdles to enacting new rules, said Satish Kini, a partner in Washington at the financial institutions group of law firm Debevoise & Plimpton LLP.
The council could call for more stringent rules by labeling money funds collectively as systemically important. Under this power, FSOC can only recommend that the SEC address the threat they pose. Before making any recommendation, FSOC must first put out a proposal for public comment and assess the costs of any proposal, Kini said.
“I suppose that this step, if taken by FSOC, may put more pressure on the commissioners, but it’s not a pathway to direct law or regulation, since it is only a power to recommend action,” he said.
FSOC also could designate individual funds or fund families, beginning with the largest, as systemically important and authorize the Fed to regulate them directly. The council hasn’t yet created the criteria for designating systemically important entities in the asset-management industry. FSOC has said it will consider adopting metrics specifically for such firms.
Designation standards would probably need to be posted for comment and adopted before designating any individual asset managers. FSOC could also run into a political opposition if it took this individual designation approach.
“Certainly it will look like an end-around the primary regulator,” Kini said. “Some members, indeed many members of Congress, would be up in arms over that.”
Schapiro’s plan was opposed by Republican SEC commissioners Troy Paredes and Daniel M. Gallagher, as well as by Democrat Luis A. Aguilar, who worked at Atlanta-based fund manager Invesco Ltd. in the 1990s.
“There is much to be investigated related to the cash-management industry, as a whole, before a fruitful discussion can be initiated,” Aguilar said yesterday in a statement. “To move forward without this foundation is to risk serious and damaging consequences in contravention of the Commission’s mission.”
Schapiro has worked to make money funds more stable since the collapse of the $62.5 billion Reserve Primary Fund in September 2008. Its closing triggered a wider run on money funds, helping to freeze global credit markets.
The run abated only after the Treasury guaranteed money-fund holdings against default for a year and the Fed financed the purchase of fund assets at face value to help the funds raise cash to meet redemptions.
Schapiro has argued the funds’ stable $1 share price encourages investors to flee at the first sign of trouble. That’s because those who react quickly can sell their shares at $1 each even if the net asset value has dropped below that level.
Schapiro’s staff this month produced a list for Congress of more than 300 instances over the past 40 years in which fund companies have sought permission from the SEC to support funds. The list was presented as evidence that funds weren’t as stable as the funds industry maintained.
Levitt, the former SEC chairman, said Aguilar’s call for more study of the matter was “disingenuous.”
“This is just outrageous,” said Levitt, who is a director of Bloomberg LP, the parent of Bloomberg News. “This issue has been studied to death.”
Schapiro’s plan would have given fund managers a choice of switching to a floating share price that reflected the market value of holdings, or establishing a capital buffer to protect against credit losses and redemption restrictions to discourage investor flight.
Industry executives said the plan would destroy the attraction of funds to investors and deny companies, cities and states a cheap source of short-term funding. Money funds can buy debt securities within 13 months of maturity, including short-term bonds issued by state and local governments and companies, as well as asset-backed securities typically issued by banks.
Fund companies and the Investment Company Institute, the industry’s trade group, said that while they welcomed the announcement, they didn’t expect Schapiro’s decision meant the end of the regulatory battle.
“I think there’s a sense of relief, but we don’t think this is over yet,” Robert F. Deutsch, head of money market funds at New York-based JPMorgan Asset Management, said in a telephone interview.
Deutsch said it was unfair to say the industry had too much influence in blocking the proposed regulation.
“We spent lots of time and money on proposed solutions,” Deutsch said. “It was only when Schapiro started to go down this path that we backed off because we were no longer having a two-way dialogue.”
Schapiro rejected an alternative proposal that would have given funds authority to halt or limit withdrawals in times of crisis, according to a person with direct knowledge of the discussions. At least two commissioners made the proposal, which would allow firms to stop investor flight similar to how hedge funds operate, said the person, who asked not to be named because the talks have been private.
The 10 biggest money-fund managers and the ICI reported combined lobbying spending of $16 million in the first half of 2012 and $31.6 million last year in disclosures that reference money-market mutual funds, according to a review of documents by Bloomberg News. That compares with $16.7 million in all of 2010.
“We believe that fund shareholders and the economy benefit from the fact that there is no current plan for further regulation of money-market mutual funds,” Adam Banker, a spokesman for Fidelity Investments in Boston, said in an e-mailed statement.
The Fed’s Tarullo has said the central bank could act on its own by limiting banks’ reliance on money funds as a source of short-term cash. Money funds are the largest collective buyer of short-term debt in the U.S. When investors fled money funds in September 2008, money funds stopped lending, a sudden withdrawal that threatened the ability of companies, including many banks, to roll over short-term debt.
Rosengren has said the Fed might require banks to set aside capital to backstop their money funds in the event of a crisis. Prominent bank-owned money-fund sponsors include New York-based JPMorgan Chase & Co., the second-largest provider with $240 billion in assets, and Goldman Sachs Group Inc., with $133 billion, according to research firm Crane Data LLC.
“In the absence of such action, there are several second-best alternatives,” Tarullo said June 12, referring to options beyond Schapiro’s proposed reforms.