SEC’s Gallagher Wants the Fed Back in its Regulatory BoxRobert Schmidt and Dave Michaels
Securities and Exchange Commission member Daniel Gallagher says the Federal Reserve is pushing even deeper onto his agency’s turf than Congress intended when it rewrote the rules of financial regulation three years ago.
Gallagher, a Republican, is fanning a conflict rooted in the 2010 Dodd-Frank law, under which the SEC lost some power to the central bank. He has publicly criticized the Fed for expanding its role in the so-called Volcker rule banning proprietary trading and oversight of money-market funds.
“Some of this is very in-your-face,” Gallagher said of the Fed’s actions in an interview. “The bank regulators seem to be driving policy, and that has got to change.”
While saying he respects the Fed’s work, Gallagher said its main regulatory mission -- ensuring the safety of banks and deposits -- requires a heavy-handed approach that won’t work for capital markets where investors accept they might lose money. The regulators, he said, should stick to what each knows best.
Speaking at the U.S. Chamber of Commerce in January, Gallagher, 40, lamented that the SEC plays “second fiddle” on the Volcker rule. In a February speech in Washington, he warned that Dodd-Frank, which he mostly opposed, limits “the commission’s ability to apply its expertise and judgment.”
Gallagher’s campaign comes after the SEC has been lambasted by lawmakers and consumer groups for its failure to properly police Wall Street before the 2008 credit crisis that led to the collapse of Lehman Brothers Holdings Inc. and Bear Stearns Cos., two of the largest brokerages subject to the agency’s oversight.
Jennifer Taub, an associate professor at Vermont Law School, said that she has “no sympathy” for Gallagher’s position because it ignores the lessons of the Wall Street meltdown, including the need for a regulator to watch for problems across the financial system.
“It’s hard to believe he was conscious in 2008,” said Taub, who is working on a book about regulatory failures.
The Fed hasn’t responded publicly to Gallagher’s criticism. Michelle Smith, a spokeswoman for the Fed, declined to comment.
While the Fed came in for its own criticism for its lax oversight before the credit crisis, much of what the central bank is doing comes with the blessing of Congress. Dodd-Frank made the Fed the overseer of “systemically important financial institutions” and gave it authority to regulate risky financial activities. Dodd-Frank also set up the Financial Stability Oversight Council to identify and respond to systemic threats.
Gallagher’s view is embraced by some Republican lawmakers and free-market analysts who argue the Fed’s push extends an implied government protection to more areas of the financial system, setting up the possibility of more bailouts. A bipartisan group of 15 ex-SEC officials also stood up for their former agency, writing a Feb. 20 letter to oversight council members urging them to let the SEC set money-fund policy.
Former SEC Commissioner Paul Atkins, a Republican and the prime mover behind the letter to the oversight council, said the signers were concerned about the SEC’s independence.
“The Fed needs to be put back in its box,” Atkins, who when he was a commissioner hired Gallagher as a counsel in 2006, said in an interview. “They have enough things to pay attention to in their own backyard.”
Gallagher said he’s been monitoring other areas of emerging conflict after comments by regional Fed officials.
Last month, Boston Fed President Eric Rosengren said that banks with brokerage units should hold more capital. He said the SEC, the primary regulator of brokers whether or not they are units of banks, has left capital rules “largely unchanged, despite the lessons of the financial crisis.” That makes brokers “vulnerable to losing the confidence of funders and counterparties” in a future crisis, Rosengren said.
The presidents of all 12 regional Fed banks put their weight behind tougher oversight of money-market funds in a Feb. 12 letter to the oversight council. Earlier that month, New York Fed President William C. Dudley argued that it may be necessary for the central bank to provide emergency lending to money-market funds and brokerage firms, a backstop now only available to banks. The price for that, Dudley said, would be formally submitting to Fed regulation.
SEC Chairman Mary Jo White, new in the post after her appointment by President Barack Obama, hasn’t taken a stance on the broad issues raised by Gallagher, one of two Republicans on the five-member commission. White told oversight board members on April 25 that money-fund reform “would best be handled by the SEC due to the SEC’s expertise.”
John Nester, an SEC spokesman, declined to comment.
The highest-profile issue shared by the SEC and Fed involves money-market funds. The funds keep a stable value of $1 a share and have long been of concern to bank regulators because small investors confuse them with bank accounts guaranteed by the Federal Deposit Insurance Corp. They played a central role in 2008 when the $62.5 billion Reserve Primary Fund imploded.
The Fed and the Treasury Department pressed the SEC for new rules. Then-SEC Chairman Mary Schapiro offered a plan last year that would have required funds to hold more capital to avert what she called the “terrifying” prospect of another run.
Gallagher refused to back it. He said in the interview that the measure was “created in strong consultation” with the Fed and Treasury. “I thought it was inappropriate that other regulators were involved in the drafting process for an SEC rule,” he said.
Schapiro withdrew a vote on the proposal last August when she couldn’t get the support of a majority of commissioners.
Using authority from Dodd-Frank, the oversight council late last year took steps that could have put money funds under the Fed. The group later backed off, saying in an April 25 report that the SEC “by virtue of its institutional expertise and statutory authority is best positioned to implement reforms.”
On the Volcker rule, Gallagher said much of the ground that the regulation covers -- deciding, for instance, the difference between hedging and trading for a bank’s own account -- is an area where the SEC has long had expertise.
“The fact that this agency hasn’t been leading the charge is unbelievable,” said Gallagher, who has called for regulators to start over on Volcker after an initial version was panned for its complexity. “We’ve been doing this for 80 years.”
Most recently, Gallagher expanded his criticism of the Fed beyond its regulatory mission. He maintains that bond investors need to be aware of perils they may face when the Fed stops juicing the economy through so-called quantitative easing.
For example, if some municipalities default on their bonds and interest rates spike, “we’ve got a real Armageddon on our hands here,” Gallagher said at an April 16 SEC roundtable discussion about fixed-income markets.