Mark Calabria’s “An End to Bailouts” (January 28) contains some interesting points, but it also contains a number of errors that substantially weaken the reliability of Mr. Calabria’s advice:
1.) Mr. Calabria decries the use of various government programs for bailouts, in particular the Treasury Department’s Exchange Stabilization Fund, which, as he says, “was used to back the mutual-fund industry. During the Clinton administration, when Timothy Geithner directed the fund, the Treasury used it to protect Wall Street investments in Mexico.” He argues that “the fund should be eliminated or, at the very least, its use should be restricted.”
Mr. Calabria should take solace in the fact that this has already been done. The Emergency Economic Stabilization Act (the law that enacted TARP) expressly prohibits the government from using this fund to bail out money-market funds. And Dodd-Frank sets forth specific mechanisms that in the future must be used for the funding of orderly liquidations and expressly prohibits using other means to fund such liquidations.
2.) In criticizing the scope of the Fed’s lending powers, Mr. Calabria states that “the Fed essentially has complete discretion in setting the terms of its 13.3 assistance [i.e., its unconventional loans in “unusual and exigent circumstances”], allowing it to save some parties while letting others fail.”
This is no longer true. Dodd-Frank limits the Fed’s ability to perform the types of emergency actions it performed in 2008 and afterward. The Fed is still allowed to set up lending facilities in certain situations, but it must clear numerous procedural hurdles before doing so. Moreover, the Fed is now permitted to offer such lending facilities only to entire classes of institutions; it is expressly forbidden to use its extraordinary-lending authority to lend to an individual entity outside of the orderly-liquidation process. It thus is simply untrue that the Fed has “complete discretion” to “save some parties while letting others fail.”
3.) In arguing against expanded deposit insurance, Mr. Calabria states: “The run on mutual funds in 2008, to the extent there was one, was caused by an unlimited extension of deposit insurance under the Transaction Account Guarantee Program. As TAG offered businesses and high-wealth households a federal guarantee, they shifted their money out of mutual funds and into banks.”
It is true that money-market mutual funds — which hold only 20 to 25 percent of all mutual-fund assets (and are the only type of mutual funds for which insured bank accounts are a viable alternative) — suffered outflows of over $1 trillion in 2009–10, and that TAG was likely a contributing factor. However, these outflows amounted to less than the inflows such funds had enjoyed in 2007–08, which totaled over $1.2 trillion. The inflows were likely due to the “flight to safety” stemming from the acute crisis of 2007–08, and thus were naturally unwound as the crisis abated. Accordingly, it is wrong to attribute those outflows primarily to TAG.
More important, those outflows can in no way be characterized as a “run” on such funds: The outflows bore no resemblance to the sudden mass of withdrawals that characterizes runs. The only run on funds occurred following the Reserve Primary Fund’s “breaking the buck” in September 2008, and that preceded the enactment of TAG. The government’s guarantee program for money-market funds, announced a few days later, did in fact end that run, as documented in the President’s Working Group Report on Money Market Fund Reform, published in October 2010.
4.) Mr. Calabria argues: “Another justification for government intervention in the financial sector was the ‘breaking of the buck’ by money-market mutual fund Reserve Primary — that is, the dropping of its net asset value below the par value of $1.00. The potential for widespread losses in other money-market funds raised the specter of bank-style runs among mutual funds. But Reserve Primary was heavily invested in Lehman debt; its losses were the result of a bad bet, not a run on mutual funds of a kind the government should offer protection against. Investors in Reserve Primary have recovered 99 cents for every dollar of investment — hardly a loss justifying a host of government interventions.”
The government did not guarantee money-market funds to stem the losses of investors in the Reserve Primary Fund; rather, it did so because the breaking of the buck set off a panic. The announcement of losses at the Reserve Primary Fund didn’t “raise the specter of bank-style runs” at other funds: It caused such runs to occur. About $310 billion was withdrawn from prime money-market funds during the week of September 15, 2008, according to the President’s Working Group Report cited above. It is reasonable to say that investors should not have withdrawn so much money at once simply because the Reserve Primary Fund had broken the buck, but the fact is that they did, and the government had no choice but to guarantee the funds. And as noted above, that guarantee worked to stop the run.
Mr. Calabria does his arguments no favors by distorting the circumstances surrounding prior government interventions in the financial system. A serious argument against such interventions needs to grapple honestly with these circumstances.
Attorney, Dechert LLP
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those of the firm or any of its clients.