September 19, 2012

Money Market Maneuvering

Hester Peirce

Former Senior Research Fellow

Robert Greene

Luce Scholar, FinTech, Henry Luce Foundation
Summary

SEC Chairman Schapiro is handing the money market regulation baton to the Financial Stability Oversight Council, the members of which appear ready to take it up. Three weeks ago, the Securities and Exchange Commission had on its calendar a meeting to vote on a proposal to further regulate money market funds. Because three of Chairman Schapiro’s four fellow commissioners did not fall into line with her plan, she had to cancel the vote.

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SEC Chairman Schapiro is handing the money market regulation baton to the Financial Stability Oversight Council, the members of which appear ready to take it up.  Three weeks ago, the Securities and Exchange Commission had on its calendar a meeting to vote on a proposal to further regulate money market funds.  Because three of Chairman Schapiro’s four fellow commissioners did not fall into line with her plan, she had to cancel the vote.  

Many commentators, including most recently former FDIC Chairman Bair, have now joined Chairman Schapiro in lamenting that her fellow commissioners recklessly rejected her valiant efforts to avert the next money market fund crisis and in calling for FSOC intervention. 

Chairman Schapiro and her chorus are jumping the gun.  Schapiro’s fellow commissioners balked, not at the need for further reforms, but at the reform options that she was putting forward.  The Chairman’s proposals could have severe effects on the $2.5 trillion industry without solving the systemic problems.

Like a bank account, if a person puts $1 into a money market fund, he typically can get $1 out. Sometimes, however, the fund’s net asset value (NAV) drops low enough that investors can’t get $1 out for every $1 put in.  This has only happened twice, most recently during the financial crisis of 2008.  That incident prompted an industry-wide run and the government jumped in to stop it.  But nobody wants either a run or a government bailout to happen again. 

The SEC made an initial set of money market fund reforms in 2010, but those reforms did not solve the problems of 2008.  Neither would Chairman Schapiro’s recent proposals, which she broadly outlined in her concession statement.

The first, a floating NAV, would require funds to abandon the fixed $1 share price that has been a core feature of money market funds.  This option has potential merit, but, without accompanying changes in the tax code, investors likely would stop using the funds.  And, as Chairman Schapiro acknowledged, it might not do much to prevent a 2008-style run. 

Schapiro’s alternative proposal requires funds to build up a capital buffer, a cushion to “absorb the day-to-day variations” in the NAV.  This is not a problem that needs to be solved, and solving it would impose tremendous expense. The Investment Company Institute estimated that, under “best-case conditions,” a 0.5 percent in-fund capital buffer would take five years to accumulate through a fund’s retained earnings. In addition to the day-to-day cushion, a crisis cushion would be funded by holding back 3 percent from investor withdrawals to absorb any losses, thereby affecting ready redeemability, another core feature of money market funds. 

Commenters such as the American Benefits Council have pointed out the difficulty of implementing holdbacks for omnibus accounts.  More generally, it would be very difficult for funds to administer this kind of a restriction and for investors to know how much of their money is available for withdrawal at any particular time.  This uncertainty could intensify investors’ inclination to run. 

The fact that the Chairman’s proposals appear as if they would reduce the usefulness of money market funds without addressing systemic risk is not a reason to reject them out of hand, but it is a reason to proceed with great care.  This is exactly what her fellow commissioners asked her to do. 

SEC Commissioner Aguilar worried “that, given the current volatility of the capital markets and the fragile state of the economy, the timing of this proposal and its collateral consequences could be needlessly harmful,” and suggested a broad concept release. Commissioners Gallagher and Paredes enumerated some very specific concerns they had with the Chairman’s proposal, including a belief that “neither of the Chairman’s restructuring alternatives would in fact achieve the goal of stemming a run on money market funds, particularly during a period of widespread financial crisis such as the nation experienced in 2008.”  They identified a potential alternative and called on the SEC’s economists to study particular issues. 

Rather than addressing her colleagues’ concerns, the Chairman stated categorically that “other policymakers now have clarity that the SEC will not act to issue a money market fund reform proposal and can take this into account in deciding what steps should be taken to address this issue.”  This statement essentially says, “FSOC, it’s your turn.” FSOC could act to make the Federal Reserve the regulator of some or all money market funds. 

Reforms are needed to make sure that money market funds can succeed and fail without government intervention. But simply throwing in the towel because three commissioners chose not to back a particular set of proposals is unacceptable.  Chairman Schapiro, instead of turning to FSOC, should still be working with her fellow commissioners -- all of whom are willing -- to design reforms that effectively address systemic money market fund problems.