A former member of the U.S. Securities and Exchange Commission recently asked me to co-sign a letter urging a federal oversight body to refrain from taking regulatory action normally left to the SEC. I believe deeply in the independence of the agency I once led, but in this case, I could not place my loyalty to the organization above the larger goal of protecting individual investors. So I refused to sign.
Every regulatory agency operates with a core mandate, and the SEC’s is clear: Promote healthy and well-functioning markets, and protect investors through appropriate regulations and enforcement actions. The SEC must always place that mission above all other goals, including its own sovereignty and independence. When it doesn’t, others may have to.
At stake are much-needed and overdue reforms to money-market mutual funds, which hold $2.5 trillion. These funds were at the heart of the 2008 financial crisis. When the Reserve Primary Fund “broke the buck,” in which the value of a share fell below $1, investors realized they would get less than $1 back for every $1 invested. The result was a run on all money-market funds, significant cash hoarding, the evaporation of short-term credit to even the best borrowers, and some of the worst days our economy has ever seen.
In the end, only the Treasury Department’s promise to make whole all investors in these funds stabilized the marketplace, but at a potential cost of hundreds of billions of taxpayer dollars.
Once thought to be very stable and risk-free, money-market funds proved to be remarkably unpredictable. One reason: Investors and fund companies both agreed to live with the useful fiction that the funds, which trade in and out of low-risk, short-term securities, would always be worth $1 a share. This implied that funds never lost money, when we now know that they frequently did. In many cases since the 1970s (the SEC counts more than 300), fund sponsors bailed out troubled funds from losses that would have undermined the $1 per share valuation.
The obvious problem is a lack of pricing transparency. There is no valuation available to investors other than the $1 per share fictional price. What investors clearly need is a floating valuation, issued in real-time or close to it.
Mary Schapiro, who made this issue one of her primary concerns in her final year as SEC chairman, strongly urged the commission to put out for public comment a floating-valuation rule, among other reforms. That’s when some money-market-fund firms ratcheted up pressure on the SEC. They objected to any reforms. With deep ties to some of the commissioners, they were able to put a roadblock in front of any new rules. They even rejected Schapiro’s effort to seek nonbinding public comment last summer.
There was no reason to block public discussion. Given the evidence of potential systemic risk posed by money-market funds, the SEC owed the public a serious inquiry. For the agency to refuse to engage the issue, even after Schapiro elevated it, struck me as a failure to meet its primary mandate.
Normally, that would have been the end of the issue. But with the creation of the Financial Stability Oversight Council under the 2010 Dodd-Frank financial-reform law, the potential for reform still exists. Congress created the FSOC -- it includes the heads of other financial regulatory bodies and has the Treasury secretary as chairman -- as an oversight body to address potential sources of systemic risk.
Money-market funds clearly fall into that category. And because the SEC could not agree to consider the potential for reform, the FSOC took it up. It conducted its own review and came to conclusions similar to my own. It now appears ready to take action.
At every turn, had the SEC wanted to take the issue up, it could have done so. The FSOC made that clear in its own deliberations and would have preferred it.
To suggest that the SEC should be permitted to act on this issue without interference is missing the obvious: The SEC would already have taken action were it not for industry interference. If anyone interfered with the regulatory process, it wasn’t the FSOC.
At this stage, I’m not even sure that opposition is very strong. While the FSOC has done its work, the money-market-fund industry has taken positive steps on its own. Several major fund groups have announced that they will begin disclosing a daily market value, or net asset value, rather than make investors wait 60 days, as SEC rules now allow.
We have also seen thoughtful regulatory reform ideas brought forward by the industry and others. While I welcome these actions, voluntary reform is never a substitute for regulatory action.
If the SEC won’t take action, it would be irresponsible for the FSOC not to. The lack of transparency in prices in money-market funds is startling; we would never permit this in any other publicly traded financial instrument.
As we saw, the orderly trading and valuation of money-market funds is essential to a healthy, functioning economy. Companies use the funds to meet payroll; families use the funds to hold cash for mortgages and college tuition payments; and institutions use the funds to raise capital for short-term needs. Failure of this market would place the U.S. taxpayer in the all-too-familiar role of guarantor.
It is understandable, even desirable, for former regulators to defend the independence of the agencies they once served. I normally find myself among the loudest defenders of the principle of regulatory independence. But in this case, the national interest -- prevention of systemic risk -- trumps all other considerations. In this case, the SEC’s mandate to protect the public interest is paramount. If it won’t pursue that mandate, the FSOC should.
(Arthur Levitt, a board member of Bloomberg LP, was chairman of the Securities and Exchange Commission from 1993 to 2000. The opinions expressed are his own.)
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