The SEC Chairman's Crusade for Money-Fund Safety
Mary Schapiro may not be able to fix what she believes is wrong with money-market mutual funds, but she’s not going to leave the Securities and Exchange Commission without trying. The SEC chairman is convinced the $2.5 trillion U.S. money-fund industry is prone to investor runs and poses a threat to the stability of financial markets. At a Senate hearing on June 21, she said that since the 1970s fund companies have acted to help their money-market funds maintain their $1 share price on more than 300 occasions.
Schapiro’s scheme for making funds safer is in a 337-page staff proposal delivered to SEC commissioners on June 25. She would give money funds a choice: Either convert to a floating share price that reveals every fluctuation in the value of holdings or be subject to a combination of capital requirements and redemption restrictions. Getting at least two of Schapiro’s four fellow commissioners to support the plan will be a challenge. The industry is opposed to her ideas—and especially loath to abandon the fixed $1 share price that has defined money funds since the first one was introduced in 1971. “Slim to none are the possibilities there,” says Peter Crane, president of research firm Crane Data. “Three commissioners have signaled they won’t accept anything that changes the fundamental nature of money funds.”
The commission could vote her plan down in July. It also might approve it for public comment, delaying a final vote at least two months and giving Schapiro time to rally support. “The chair will place the issue before the commission and, if the vote fails, contemplate other options,” says Karen Shaw Petrou, a managing partner at Washington research firm Federal Financial Analytics.
For 40 years, money-market funds have offered individuals and corporations a convenient place to park cash, usually offering higher returns than insured bank accounts. They have become the largest collective buyer of U.S. commercial paper, serving the short-term borrowing needs of banks and other companies, from General Electric to Toyota.
At the Senate hearing, Schapiro recalled how a run on money funds in September 2008, following the collapse of the $62.5 billion Reserve Primary Fund, brought credit markets to “the edge of a cliff.” The panic spurred the U.S. Treasury to temporarily guarantee more than $3 trillion in money-fund assets. Congress has since barred Treasury from issuing such guarantees. “Every morning when I pick up the newspaper and read about an earthquake in Japan or problems in European financial institutions, the first question I ask our staff is ‘What is money-market-fund exposure?’” Schapiro told lawmakers.
A floating share price, Schapiro has argued, would remind investors that money funds are subject to market movements and are not insured savings accounts. It would also reduce the risk of runs by removing an incentive to flee at the first sign of trouble. If the funds strive to maintain a $1 share price in a crisis, fast-moving clients could get out without losses even if the market value of the fund’s holdings has fallen slightly. The departure of those investors concentrates losses in the hands of those left behind.
Funds that want to stick with a steady $1 share price would set aside cash to absorb losses when their holdings fall permanently in value. They also would have to require investors pulling out to leave a small percentage of their money in the fund to cover potential losses. That would remove any reward for fast movers.
Fund companies see the proposals as a threat to their existence. “The goal all along has been to kill money funds,” says J. Christopher Donahue, president and chief executive officer of fund company Federated Investors. He says the new rules would destroy the attraction of money funds by removing their stable value and daily liquidity. That would deprive corporations, municipalities, and many other institutions of a cheap form of short-term financing. Schapiro’s reforms would “severely damage the municipal finance and commercial paper markets” at a delicate time in the economy’s recovery, wrote James Angel, associate professor of finance at Georgetown University, in a June 19 paper financed by the U.S. Chamber of Commerce.
The SEC in 2010 put through one round of reforms designed in part to ensure the funds could raise a lot of cash quickly to meet investor redemptions. As a result, prime funds, or those not limited to government-backed debt, are now able to generate at least $417 billion in cash within seven days as borrowers pay off the debt the funds hold. That reduces the likelihood that the funds would have to sell holdings at a loss during a crisis.
Those reforms proved their worth when money funds weathered the U.S. credit rating downgrade, the debt-ceiling showdown in Washington, and several stages of Europe’s sovereign-debt crisis, says Paul Schott Stevens, president of the Investment Company Institute, a Washington-based trade group. “We feel we were the first part of the financial system comprehensively reformed after the financial crisis and the first part to be severely tested,” Stevens says. “And we came through it very well.”
Schapiro can count on only one supporting vote on the commission, that of Democrat Elisse Walter. Republicans Troy Paredes and Daniel Gallagher have said they oppose the plan. While Democrat Luis Aguilar hasn’t been as explicit, he joined the two Republicans in a May 11 statement objecting to a report from the International Organization of Securities Commissions outlining possible money-fund reforms.
Since that statement the industry has grown confident that it has escaped significant reform, at least this year, two senior fund-company executives and a third person familiar with the industry’s views said in separate interviews. All three asked not to be identified because they weren’t authorized to speak publicly. Not that they feel they are completely out of the woods. Should President Barack Obama win reelection, all three said another push for new rules might come next year.