Geithner to SEC: Get to Work, or We'll Do It for You

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By Deborah Solomon

Only in the bureaucratic world of Washington could Treasury Secretary Timothy Geithner's letter today urging regulators to strengthen their oversight of money-market mutual funds be viewed as progress.

But progress it is.

Geithner has recommended the Financial Stability Oversight Council begin the process of regulating the funds in the event the Securities and Exchange Commission is "unwilling to act in a timely and effective manner."

Translated, that means the FSOC is prepared to do an end-run around the SEC. But that end-run won't happen quickly.

Geithner is recommending the council release for public comment several options to overhaul regulation of an industry that poses well-known threats to the financial system. Geithner said he's "hopeful" the group can vote on its recommendation at its November meeting. His letter arrives just before an FSOC meeting planned for Friday.

In the meantime, Geithner essentially said the SEC should get its act together and try to regulate the industry itself.

Regulators, including the FSOC itself, have long viewed money-market mutual funds as a threat to the financial system. The funds played a starring role in the 2008 financial crisis. When Lehman Brothers went bust, the Reserve Primary Fund was left holding $785 million in essentially worthless IOUs. Reserve investors wanted their money back but -- for the first time -- the fund couldn't pay back everyone's money and "broke the buck" by failing to maintain the traditional $1 share price. That created a domino effect, in which the commercial-paper market froze and companies that rely on short-term financing were unable to finance inventories, payrolls and general operations. The Treasury and Federal Reserve had to step in and guarantee the funds to break the bank run.

Last summer, SEC Chairman Mary Schapiro abandoned her efforts to get the SEC to impose tougher rules on the industry after she was unable to get enough votes to pass the initiative. Democratic commissioner Luis Aguilar -- who previously worked in the fund industry -- refused to commit to the reforms, and Schapiro pulled the plug on a vote.

That left the FSOC, a council of regulators created by the Dodd-Frank law to prevent financial-system risk, with a big question about whether to step in. The group has the power to designate a mutual fund company as a "systemically important financial institution," which would subject a fund to tougher oversight and require it to hold more cash.

I've written before that the FSOC should move swiftly to do this. It's no secret that money-market mutual funds pose risk, and there doesn't seem to be much effort on the part of the SEC to deal with it. The FSOC was set up to deal with exactly this type of situation.

Geithner's letter is encouraging. Then again, this is Washington, and it's easy to see how this whole process could get bogged down in the bureaucracy that so often imperils well-intended efforts. To date, the FSOC has yet to designate a single non-bank financial firm as "systemically important" -- not because it doesn't know which ones pose risks, but because it is taking painstaking efforts to make the process transparent and fair. The threat of legal challenges to any FSOC action is real.

In an ideal world the FSOC would move money-market mutual funds to the top of its agenda. Then maybe the SEC, seeing this end-run as a challenge to its authority, would finally take the steps necessary to regulate a risky industry it's responsible for overseeing.

(Deborah Solomon is a member of the Bloomberg View editorial board. Follow her on Twitter.)

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-0- Sep/27/2012 22:33 GMT