Yesterday, the Treasury’s Financial Security Oversight Council (FSOC) tried to act on one of biggest SEC failures since the financial crisis — regulating money market funds.Back in 2008 money market funds almost brought the global economy to its knees when the Reserve Fund, the U.S.’s biggest money market fund, set off a run.
The problem was that it owned $785 million in Lehman Brothers’ commercial paper, so when the bank collapsed, the Reserve Fund could no longer claim that it’s shares were worth $1.
That’s when the run started, and it spread to money market funds all over the world. The Treasury had to step in, using the power of its Exchange stabilisation fund to shore up markets, but since that day little has been done to change the way we value money market funds.
There are $2.6 trillion in these funds and they are supposed to be safe, higher yield alternatives to banks. Companies use them to finance their day to day operations. However, the problem is that they’re backed by assets — those assets are usually short-term, low risk assets, but still — if their value depreciates so does the value of the fund.
In August three members of the SEC went against Chair Mary Shapiro and blocked money market fund reform that would have spelled out the truth about these funds — that their value fluctuates based on the assets that underlie them.
Critics, including Treasury Secretary Geithner, railed against this failure. That’s why yesterday, the FSOC tried to pressure the SEC to make things right by suggesting reforms that largely echo those the SEC rejected in August.
- Alternative One: Floating Net Asset Value. Require MMFs to have a floating net asset value (“NAV”) per share by removing the special exemption that currently allows MMFs to utilise amortized cost accounting and / or penny rounding to maintain a stable NAV. The value of MMFs’ shares would not be fixed at $1.00 and would reflect the actual market value of the underlying portfolio holdings, consistent with the requirements that apply to all other mutual funds.
- Alternative Two: Stable NAV with NAV Buffer and “Minimum Balance at Risk.” Require MMFs to have an NAV buffer with a tailored amount of assets of up to 1 per cent to absorb day-to-day fluctuations in the value of the funds’ portfolio securities and allow the funds to maintain a stable NAV…
- Alternative Three: Stable NAV with NAV Buffer and Other Measures. Require MMFs to have a risk-based NAV buffer of 3 per cent to provide explicit loss-absorption capacity that could be combined with other measures to enhance the effectiveness of the buffer and potentially increase the resiliency of MMFs. Other measures could include more stringent investment diversification requirements, increased minimum liquidity levels, and more robust disclosure requirements…
This seems like a no-brainer. Force funds to disclose their actual value and hold capital in the event of disaster. The question is why wouldn’t the SEC be able to pass regulation like this?
James B. Stewart of The New York Times explains why:
Though Republicans in Congress have generally sided with the mutual fund industry, and the reforms emerged from a Democratic administration, several people I spoke to said it was a mistake to view the outcome through the prism of partisan politics. “It’s not Republicans versus Democrats,” a person involved in formulating the proposals told me. “It’s the mutual fund industry and its allies versus the American taxpayer.”
Let’s hope the FSOC is able to put enough pressure on the SEC so that they take up this issue again.
We’ll be watching closely.
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