Always looking for new ways to spread its influence, the Securities and Exchange Commission is contemplating taking another step towards stricter regulation of America’s $2.5 trillion in money-market funds. Interestingly, while the regulators have recently accused the funds of being “brittle”, “subject to runs,” and “shadow banks,” they really are known for their stable value and easy redeemability, qualities that, over the years, have enabled retail investors and corporations to use them pretty much like they would use bank accounts. In fact, the main difference with bank accounts is that money-market funds are not usually backed by a government-insurance plan.
Concerns among professional worriers and believers in the idea that government can crisis-proof the world (those often being the same people) grew after the September 2008 collapse of a $62.5 billion money-market fund called the Reserve Primary Fund. The Fund held some Lehman securities, and as they say in the business it “broke the buck” (fell below $1 in deposited value). As the news spread, investors ran from the Reserve Fund, as well as other money-market funds.
#more#At first, the government responded with a temporary insurance program. It completed the “rescue” in 2010, through the SEC tightening of money-market rules. As my colleage Hester Peirce explained recently:
The changes sought to make money market funds more liquid, less risky, and easier to manage in the event of a run. The SEC warned that additional, deeper changes – capital requirements, a move away from the stable $1 net asset value, and new limits on redemption – could follow.
According to Bloomberg News, the chairman of the SEC, Mary Schapiro, is now pushing new rules that could include capital requirements or a change to the industry’s traditional $1 share price. Thankfully, she may have a hard time convincing the five-member committee. Her biggest hurdle is going to be convincing them that that one should reasonably fear mutual-fund runs, considering the industry’s long standing reputation as one of the safest-constructed investments available.
A week ago, in the Wall Street Journal, Charles Schwab, founder of the financial-services company of the same name, ran an open letter to regulators making that case. He writes, for instance, that money-market funds are more lucrative than regular bank accounts (they paid $260 billions more in dividends that what investors would have received in interest from bank accounts, but they remain a safe investments, as their four-decade-long record can attest). They are only allowed to invest in short-term fixed-income securities. Schwab explains, “At least 97 percent of a fund must be held in securities with the highest short-term credit ratings.” They have no liabilities, only assets, and as such they aren’t in the business of leveraging their holdings.
In addition to the SEC oversight that was increased in 2010, the funds managed under the Company Act of 1940 are overseen by an independent board of trustees, independent legal counsel, and independent auditing firms. In other words, the funds are already highly regulated.
Schwab also put the Reserve Fund troubles in perspective. The Fund broke the buck in the depth of the crisis, and only lost 1 percent of its value. “Breaking the buck” has only happened twice in the history of the industry. By contrast, he writes, “just since 2008, more than 500 banks and credit unions have failed, costing investors and taxpayers more than $80 billion.”
More importantly, it is not the role of the SEC to remove risk from investments. As House Financial Services Committee chairman Spencer Bachus and Representative Jeb Hensarling, vice chairman of the financial-services panel, explained in the letter to Chairman Schapiro last month:
We would also like to remind you that the SEC’s mandate is to ensure that investors have all of the material information about an investment, not to engineer investments so that they are free of any risk,” the lawmakers wrote. “If investors do not understand that their investments in money-market funds can result in losses, then the Commission should use its existing authority to enhance disclosures rather than change the fundamental characteristics of money-market funds.
As Bachus and Hensarling also noted in the letter, the SEC is already struggling to meet deadlines to implement rules mandated by the 2010 Dodd-Frank Act. Now is not the time to add more rules to an already well-regulated and well-functioning industry, especially considering that there is a chance that these new rules related to stability and capitalization would make the products useless.
Finally, Peirce offered some interesting comments about how to improve — or not improve — the industry. She made the following 5 points:
First, we need to reject the assumption that once one product has a government guarantee, every product needs one. Slapping government insurance on one sector after another undermines the financial system’s stability by replacing investors’ natural inclinations to monitor the keepers of their money with clunky, inflexible regulatory oversight. [...]
A second principle is that the stable $1 share price is a regulatory fiction, so its proponents should bear the burden of justifying it. The run began when market realities cracked this regulatory fiction. [...]
Third, a poorly designed or inadequate capital buffer or insurance requirement for money market funds would be worse than doing nothing at all. [...]
Fourth, because money market funds are so large, constraints on their holdings affect the companies and governments that depend on them for funding. [...]
Finally, new constraints that homogenize money market portfolios could magnify a future crisis. [...]
Read the whole thing here.
I doubt the idea that government can, somehow, create a risk- and crisis-free world will ever go away. It is too bad because that world doesn’t exist. And while there are a few ways to reduce one’s exposure to financial crisis and to avoid spreading the cost to everyone, it’s not the job of the government. Besides, if history is our guide, when government has tried, it has failed and it has often enhanced the problem. The best way, while not perfect, is to let the people who invest their money figure out how best to protect their investments. The alternative — a government-produced solution — is an illusion that will never produce the expected results but always end up costing taxpayers a lot of money.