BREAKING THE BUCK ALMOST BREAKS MY BACK
Success is not final, failure is not fatal: it is the courage to continue that counts.
When Mary Schapiro asked me to be the director of IM, she could not have predicted that one month later the commissioners would devolve to bitter finger-pointing over how to protect the money market mutual fund industry that had nearly crashed and burned billions of investor dollars in 2008. My predecessor at IM had circulated a policy proposal on new rules for these funds earlier in the summer of 2012. Soon after taking the director job, I learned that the proposal included measures to reform money market mutual funds that would make them more like savings accounts at your local bank than the riskier securities funds and products the SEC regulated.
Money market mutual funds buy market instruments like bonds and take the risk of those investments going up and down. Bank products such as savings accounts do not fluctuate in value and are insured by the federal government. By forcing mutual funds to hold capital reserves, as banks do, IM’s proposal would reduce the vital risk taking of the U.S. markets. I had a feeling that the proposal was headed for trouble; however, I was not prepared for the meltdown that followed.
On August 22, 2012, Schapiro issued a surprisingly strong-worded press release stating that she did not have the three votes needed to make the proposal public and describing the proposed reforms she supported. In part, the release read:
One of the most critical lessons from the financial crisis is that, when regulators identify a potential systemic risk—or an industry or institution that potentially could require a taxpayer bailout—we must speak up. It is our duty to foster a public debate and to pursue appropriate reforms. I believe that is why financial regulators both past and present, both Democrats and Republicans, have spoken out in favor of structural reform of money market funds. I also believe that is why independent observers, such as academics and the financial press—from a variety of philosophical ideologies—have supported structural reform of money market funds, as well.
The issue is too important to investors, to our economy and to taxpayers to put our head in the sand and wish it away. Money market funds’ susceptibility to runs needs to be addressed. 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.1
Then things got ugly. Another Democratic commissioner, Luis Aguilar, issued his own statement asking for more study of the problems of money market funds.2 Newspaper reporters called every five minutes looking for comment, and I couldn’t get the commissioners to engage on what path might work.
Right before the controversy exploded in the public eye, I managed to get Commissioner Aguilar on the phone. I asked him if there was anything I could do to modify the proposal that would help. He said that the proposal as it stood would not get his vote as it didn’t address issues like money market business flowing to private, less-regulated funds. A few days after Aguilar’s statement, Republican commissioners Troy Paredes and Dan Gallagher issued their own statement asking that the commission’s economists do more work to evaluate potential reform options and their likelihood of success.3 The whole mess was front-page news in the Wall Street Journal and other papers.
It was quite a welcome to the world of policy making in Washington, DC. It also illustrated the fragility of one of the most important features of the U.S. financial markets. Let’s take a look back at how we got here.
THE SEC SELLS A PIECE OF ITS SOUL, LIVES TO REGRET IT
In 1980, the SEC strayed from its mission, a mission born in securities laws that became a model for free economies worldwide. It was a departure, and a rare one. In my view, when you stray from your core values and carve out a piece of your soul as an organization, it may take 30 years, but you’re eventually going to regret it. That’s what happened after the 2008 crash and then culminated in a bitter Beltway cage match over how to “fix” the $7 trillion money market mutual fund industry.
When a new investor learns personal finance 101, from whatever source, that new investor will learn the same core concepts grounded in the structure of the U.S. financial industry first set down in law during the 1930s. First, it’s important to save money and then take advantage of interest-bearing opportunities so that your investments grow over time. Therefore, as an adult, you no longer need a piggy bank, coffee jar, or hidden safe for your cash. Second, you can have diversified savings that include federally insured bank accounts where you can’t lose a penny for amounts under $250,000; federal, state, and city government bonds that are similarly exceedingly safe (a “savings bond” is a government bond); and various kinds of securities that have higher levels of risk. The more money you can afford to lose in the short to medium term, the more you can invest in stocks, mutual funds, and other securities.
Bank accounts more or less ensure that short of a zombie apocalypse or the rise of a supremely evil army of master hackers, if you put a buck into an account, you will at least get a buck out. Bank interest rates generally don’t provide much of a return on your money and since the 2008 crisis have hovered near zero. To get better returns on your money, you have the option of taking part of your savings and going to a different kind of store to buy stocks and shares in mutual funds.
You can shop at this other investing store that has been very successful but doesn’t guarantee your dollar. You hand over a buck, and you’re hoping that a money manager as good as Peter Lynch at Fidelity, John Bogle at Vanguard, or Warren Buffett at Berkshire Hathaway invests your money so that it does great for you—that is, earns higher returns over time than the interest that banks pay. That’ll be great for your retirement, your family, and your enjoyment of life.
That’s the normal bargain. But in 1980, the SEC changed the bargain with money market mutual funds, partly because bank deposit interest rates were capped by a Depression-era law (another unintended consequence). It became possible for the investing store to offer higher rates of returns than were possible at the bank store, but if you asked the shopkeeper, he’d still give you all your money back that you initially invested.
Thus you have the idea of the twenty-first century’s multitrillion-dollar money market mutual fund industry, which became the bedrock of everyday securities accounts for millions of middle-class investors. This couldn’t have happened, however, unless the SEC changed federal securities rules. And that’s what the SEC did in 1980—in a rare decision to cater to the industry it regulated.
That year, the SEC passed an exemption to benefit the money market fund industry. This exemption, known as Rule 2A-7, allowed these funds to seek to maintain a stable $1 net asset value (NAV) by using penny rounding and amortized cost accounting. Amortized cost essentially allows the mutual fund to count a short-term bond as worth its cost even if the market says it is worth a little less. This convention, coupled with allowing the fund to round up a 99 cent valuation of its shares to $1, enables money market funds to stay at a “stable” $1 share value. This meant these funds did not have to comply with the mark-to-market valuation standards required for other mutual funds. (If you put a dollar of cash into a money market mutual fund, no matter what happens to the fund’s investments, you can get your dollar out, which is not true of other mutual funds.)4
In exchange, the money market mutual funds relying on Rule 2A-7 had to follow strict limitations on their investments. The SEC told them, OK, Mr. Money Market Fund managers, you need to buy lots of short-term debt so your holdings are liquid and you’re not exposed to excessive long-term risk in stocks and derivatives. Like so many actions by policy makers, these limits on what money market mutual funds could invest in had an unintended consequence. They created a massive appetite in investment markets for short-term high-quality debt, or what is called “commercial paper.”5 This meant banks and other companies used commercial paper like a cash spigot to run their businesses. They issued short-term debt notes to a ready-made group of buyers in money market mutual funds that snapped them up. Thus the money market funds became a daily source of billions in cash for U.S. companies, including banks and investment houses, to run their businesses!
Many at the SEC, including my friend Commissioner Aguilar, argued to me that money market mutual funds provided a convenience and benefit for investing customers that the SEC shouldn’t sacrifice as part of reform. My concern was that fund managers loved money market mutual funds because their reputation as being safe meant that customers kept their money in the managers’ money market mutual funds after the customers sold stocks, bonds, or other mutual funds. Managers got to keep more of the investors’ dollars in-house and collected fees when the customers again deployed their cash to buy stocks and bonds. The funds were a good deal for investment managers too, but most investors didn’t realize this. I remember making these points with Commissioner Aguilar and telling him, “Yes, they’re convenient for customers, but they’re also good for the house because you keep your cash with the house when you might not otherwise.”
With money market mutual funds, it became commonplace for small and large investors to use them as they did bank accounts, writing checks and making withdrawals as needed. Consumers with money market funds behaved at the opposite end of the spectrum from the investing gurus who advise buying stocks “for the long run” and using investment dollars to “buy and hold” over numerous market cycles. Investors treated money market mutual funds like bank accounts that they used for everyday transactions, blissfully ignoring the fact that these funds did in fact hold securities whose value could change.
Consumers liked the strong sense of stability offered by the walls of the $1 NAV. The walls might rumble in a storm but never crumble and fall. Their money market holdings were in a kind of metaphoric sealed vault with other account holders’ money.
But what happens in a market downturn where the headlines are scary and people are losing their investments? The money market fund customers want to get their funds out of the vault first. “MMFs are vulnerable to runs because shareholders have an incentive to redeem their shares before others do when there is a perception that the fund might suffer a loss,” stated the 2010 findings published in a report of the cabinet-level President’s Working Group on Financial Markets. The report continues:
When a fund incurs even a small loss because of those risks, the stable, rounded NAV may subsidize shareholders who choose to redeem at the expense of the remaining shareholders. A larger loss that causes a fund’s share price to drop below $1 a share (and thus break the buck) may prompt more substantial, sudden, destabilizing redemptions. Moreover, although the expectations of safety fostered by the stable, rounded $1 NAV suggest parallels to an insured demand deposit account, MMFs have no formal capital buffers or insurance to prevent NAV declines.6 (My emphasis)
Thus we arrive at 2008 and the financial storm of the century (so far). By this point, the money market fund industry was huge. Pension plans and endowments, following bylaws requiring them to set aside cash in safer vehicles, had parked billions in money market funds. Institutional investors were more sophisticated than retail investors and have larger investments at stake. So they responded with greater urgency when they perceived a threat to the stability of the funds.
So when the Lehman Brothers bankruptcy in September 2008 sent the floodwaters of the crash over the walls of the world’s largest money market funds, the institutional investors led the frenzy of withdrawals, nearly collapsing dozens of household-name funds.
THE RESERVE PRIMARY FUND BREAKS THE BUCK
In the 30-plus years since the SEC’s adoption of Rule 2A-7, money market mutual funds have rarely broken the buck. Losses on short-term bonds did not cause major disruptions to the buck and were often shored up by money market fund managers adding their own cash to the funds to mask any problems.7 Then September 12, 2008, came, and Lehman went down. As a result, the Reserve Primary Fund, a $62 billion money market mutual fund, broke the buck. This fund held $785 million in commercial paper issued by Lehman Brothers. When Lehman went bankrupt, Reserve Primary Fund shareholders freaked out and started redeeming shares (withdrawing funds) to the tune of $40 billion in just two days (that’s over two-thirds of the entire fund!). Adding to the panic, the Lehman debt owned by the Reserve Primary Fund was now worth zero. The fund began selling off its portfolio to pay redemptions. Unlike other funds with a mega-capitalized sponsor (say a Fidelity or State Street), Reserve had no other entity to call on, step in, and replenish its capital reserves.
On September 16, Reserve announced that the Primary Fund would break the buck and reprice its shares at $0.97.8 A few days later, the SEC announced that investor redemptions of Reserve fund shares would be suspended “to permit their orderly liquidation.”9 Uh-oh.
Now many investors wanted their cash, particularly institutional investors, and they wanted their cash right now. I remember thinking at the time, “This is about as scary as you can get.” If you have a money market fund, you are thinking, “I want my cash. I want out.” Everyone wants out. During the week of September 15, investors withdrew about $300 billion (14 percent of assets) from prime money market mutual funds.10
Neil Irwin, who was a Washington Post economics editor and blogger, wrote:
Money-market mutual funds serve as part of the bedrock of the American financial system, serving as a way for millions of Americans to save money in a financial product that (normally) offers better returns than bank savings accounts and is (normally) very safe—and then funnels that money to companies that issue short-term debt, thus funding their operations.
How do we know that this system has flaws? Because they nearly brought down the financial system in 2008.11
You get what happens next.
To meet the flood of redemptions, money market funds burned through their cash and sold off their securities into crashed markets where no one was buying. These efforts slashed prices of short-term bonds and impacted fund portfolios, threatening the NAVs of the funds.12 It was a near-Chernobyl money meltdown for funds as they burned away the billions in cash they could access to pay back their investors. In that terrible two weeks, fortunately only the Reserve Primary Fund broke the buck, as some fund sponsors made money transfers to their funds to prevent capital losses.
During September 2008, money market funds in the United States reduced their buys of commercial paper (the short-term notes companies used to raise cash) by about $170 billion, or one-quarter of their total holdings. Now the cash was barely dribbling out of the commercial paper spigot, and huge companies needed to pay workers and keep the lights on. So they drew down their backup lines of credit, which placed additional pressure on the balance sheets of commercial banks.13 Suddenly all kinds of companies were in panic mode.
It only took 11 days. The U.S. Treasury and the Fed stepped in on September 19, 2008, to essentially guarantee all the money market funds in the United States. Treasury’s Temporary Guarantee Program for Money Market Funds provided stopgap guarantees for shareholders in money market funds that elected to participate. The branding wizards at the Fed installed a new bailout program less than memorably entitled the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility (AMLF), which extended credit to U.S. banks and bank holding companies to finance the purchases of high-quality asset-backed commercial paper from these funds. Several other interventions provided support for the money market fund industry and short-term funding markets. The Guarantee Program and the AMLF expired in 2009 and 2010, respectively.14 All these steps had calmed the waters enough so that they weren’t needed.
These events were fresh in the minds of the participants as the controversy over money market fund reform hit the fan in fall 2012.
FED UP
The SEC got hit hard in 2008 and 2009. We tend to forget the magnitude of the beatdown. The SEC was in the unenviable position in Washington, DC, of being both pitied and scorned. The front-page financial rescues of the time had sent the SEC back to the kitchen, taking out the garbage after the party was over. It was the Fed and the U.S. Treasury that had the huge budgets, palatial conference rooms, famous names, and friendships at the White House, with the media portraying Geithner and Bernanke as storming in on their white horses to save the world from financial collapse. The SEC was seen as the bureaucratic necessity that no one liked, a dysfunctional mess best kept away from the adults’ table. Some of this was deserved, as I have amply documented in these pages.
The lopsided power struggle with the Fed and Treasury formed an important backdrop to efforts to pass money market mutual fund reform. The conflict later deepened during the SEC’s and my wrangling with the Financial Stability Oversight Council (FSOC). This was a powerful body of interagency regulators chartered by Dodd-Frank to keep watch over the financial industry and designate institutions that were systematically important to the U.S. financial system. Being designated put these firms on the FSOC’s short leash by subjecting them to additional regulations and oversight by the Fed.
The SEC’s numerous failures gave the Fed and Treasury leverage in battles over issues like money market fund reform. When the SEC couldn’t stop the money market fund industry from going under, Fed and Treasury had to guarantee the funds. When the global leaders of the broker-dealer industry like Goldman Sachs and Morgan Stanley nearly all collapsed at the same time, the SEC could do little while the Fed made them bank holding companies to bail them out. Then a couple of months go by and the world discovers that Madoff is a fraud and the SEC missed the chance to stop him a number of times. By the end of 2008, the SEC had taken the fall from hell. Everything it touched seemed to turn to dust.
These early fights with the Fed scarred a number of SEC personnel including a few who screamed at me during our negotiations over money market reform, saying things like “Tell the Fed to go screw themselves.” I often said we have to understand the Fed’s point of view. If you are a Fed person, you are thinking, I just spent the crisis cleaning up the SEC’s mess. Why should I listen to the SEC?
BOILING POINT
Despite the fall from hell, the SEC emerged in 2010 with its rule-making ability intact, and it adopted new rules regulating money market funds. One rule required each fund to have more liquidity of its assets (ability to pay cash) to meet redemption demands for investors. Funds needed to be ready for a “run on the bank.” They needed to be able to turn at least 10 percent of their holdings into cash in a single-day period and meet a 30 percent requirement in a weekly period. Second, the SEC ruled that the funds had to be more conservative in their investments. The new rule limited each fund’s maximum holdings of “second-tier” securities, which carried more risk than first-tier securities, to 3 percent or less of their assets. Finally, the rules also required that the funds carry more short-term bonds (because this makes their assets more liquid), and said fund managers had to periodically “stress-test” their funds against hypothetical events, such as a change in short-term interest rates, to understand how much they would lose and whether they would “break the buck.”15
Now remember how I was sitting with Mary Schapiro after Didem raised the possibility of becoming director of IM? Mary had mentioned that money market fund reform was the biggest challenge facing her as the IM proposal on the subject was on the commissioners’ desks.
She said that a share price for such funds that reflected the actual market value of the securities held (thus “floating”) was part of the proposal. I blurted out, “To me these are mutual funds, and we should stop hiding the risk from investors. The commission should change the $1 fixed price per share for these funds to the floating price.”
This was a bit aggressive considering I wasn’t quite sure where Mary stood on the issue. She nodded her head in a friendly manner and changed the subject.
By August 2012, I was starting my first days as the new head at IM. The money market fund plot had thickened, and the tension was building between the Fed, FSOC, the SEC, and Congress over who would control how the final rule would be written Schapiro was prepared to submit her proposed new rules for money market funds based on a proposal written by one of the senior officials from IM. Now that I had the new job, I read the proposal soon after I arrived and had many misgivings. It turned out I wasn’t the only one.
While it was technically proficient, the policy appeared to be designed by the bank regulators at the Federal Reserve Board and not based on an analysis by the SEC’s own economists. The proposal included capital requirements for money market funds and a holdback of investors’ funds.16 These steps would turn an investment vehicle into a safe, Main Street–type bank account. Proponents claimed this was “cracking down” on the industry, but I saw it as overkill and overreach. The 2010 measures had already required fund managers to install more safeguards while not removing all the market incentives (that is, to get a better return than CDs) that made them successful in the first place.
With the SEC being punched back on its heels time and again because of Madoff, Stanford, and other scandals, the Fed and Treasury had huge clout. They were the cool people at the Beltway high school, and turning brokers into banks was the big fad. It seemed to me some people at the SEC had fallen under the Fed’s influence, including the design of the 2012 money market fund reform proposal. The commissioners of the SEC wanted nothing to do with Obama’s regulators at Fed and FSOC taking over money market reform. They had reservations about the Fedlike idea of watering down the risk in money markets, but Schapiro thought she could still get two out of the four of them to vote with her and authorize its issuance by a 3–2 vote.
She was wrong. The proposal was not brought to a vote in August 2012 because Democrat Luis Aguilar was the swing vote who, along with the two GOP commissioners, said he wouldn’t vote for it. Luis knew the industry well, and he strongly believed the proposal was bad for consumers who didn’t dabble in complex investing. The next day he issued a statement arguing that any reform of money market funds should only be made after additional study of the entire U.S. cash management industry and the impact of the SEC’s previous money market fund reforms in 2010. The commissioner worried as I did of unintended consequences: “I remain concerned that the Chairman’s proposal will be a catalyst for investors moving significant dollars from the regulated, transparent money market fund market into the dark, opaque, unregulated market. Currently, in addition to all the prescriptive conditions applicable to SEC-registered money market funds, these funds are also highly transparent to investors and regulators in a way that other cash management vehicles are not.”17
For my situation, as stressful as the whole lost vote was, it resulted in one important example of addition by subtraction.
The IM official who’d written the proposal took it personally when the commissioners did not vote to publish it. He was also uncomfortable because I don’t think he believed in the project to try to change the Wax Museum (although we got along well personally). When I started the new job, I sat down with him.
I said, “OK, let’s say the money market funds rule passes or goes away. What are we going to work on next? What is our pipeline?”
He mentioned that he had 50 or 60 project papers on the shelf in his office. He called them “shelf projects” and he’d pull out a couple of those for IM to work on next.
“Wait a second,” I said. “Is this how the U.S. is making financial policy? Have we evaluated those 60? How do we pick one?” This was a well-meaning and well-qualified official. But the commissioners and other experts within the huge agency should have more analysis to decide what policies to propose.
We all worked to count up these shelf projects. It turned out there were 72 possible rule projects on the office shelf. In a good year the Division of Investment Management maybe gets two rules through the commission, so the 72 represents a 36-year plan! To be fair, SEC culture didn’t demand much rigor in setting priorities.
I told him that we were going to analyze the shelf projects for their feasibility, affordability, and strategic value. Hardly a radical idea! I wanted to get wide input from others to help us make sense of the priorities.
When the commissioners refused to vote on the draft money market fund proposal, that seemed to be the last straw, and he told me he was resigning. I accepted his resignation, seeing this as an opportunity to bring in some fresh thinking. We ultimately narrowed the shelf projects down to just a few that we could prioritize.
THE MORNING AFTER
When Commissioner Aguilar suggested the SEC should do an economic analysis of the issues remaining with money market funds, he was hit with a lot of negative spin from some Democrats and the press. The media picked up the administration’s messaging that the industry needed a crackdown rather than common sense. After all, what the three commissioners who said they would vote no were saying was simply this: can we please slow down and study this some more before piling on more regulations?
Before you know it, bing-bang-bing, former SEC chairman Arthur Levitt went on a radio show and called Aguilar a “villain” for requesting further study.18 The New York Times reported on August 26, 2012, “Mr. Aguilar derailed one of the most significant current efforts to tighten regulations on the financial industry. His opposition to a proposal put forward by the S.E.C. chairwoman, Mary L. Schapiro . . . put Mr. Aguilar in lock step with the powerful and aggressive mutual fund industry in which he worked as a lawyer from 1994 to 2002.”19
In the Wall Street Journal one commentator labeled the SEC “toothless” and asserted “anything is better than the ‘let’s study this issue to death’ approach taken by SEC commissioners such as Mr. Aguilar. The financial crisis proved money funds are a real risk, and the notion that their unit values are always $1 is a fiction. Action, not further study, is needed.”20
Politico published one of its instant trend stories that made it clear the reporter didn’t know how the SEC worked. “Dems Shy from Money Market Reform,” Politico big-and-bold-typed on its front page. Why? Well, according to Politico, if Aguilar, a commissioner of a nonpolitical agency, voted against the proposal, then somehow Hill Democrats were behind the no vote as the consensus of a partywide view.21 That was an insult to Aguilar and the commission. The Washington Post published a more balanced story, but almost no one got it right.
I liked Schapiro and Aguilar—and all the other commissioners. I worked for the chair, but my good relationships with the other commissioners meant a great deal to me. I had learned long ago in my childhood how to defuse conflict, and we needed a new start. Mary had been right to identify the money market fund industry as needing further reform, but the proposal had been co-opted by the pro-Fed elements within the SEC. She probably pushed the commissioners too hard at the eleventh hour, rather than working behind the scenes with Luis. But that was a rare miss for her.
I now had an opportunity to help out Schapiro and the commissioners and to do my job by seeing if I could get reform back on track. But I’d have to contend with the rising power over at FSOC.
F-SOC IT TO US
Commissioners Aguilar, Gallagher, and Paredes couldn’t support Schapiro’s proposal because it was a Fedlike bank solution, but the lack of an SEC proposal had the effect of giving FSOC an opening to take over the issue. Once the Schapiro package was stalled at the SEC, she asked the superbody of financial regulators to take up the problem, playing right into their hands.
Washington Post columnist Irwin definitely, really got it. He quoted Treasury Secretary Timothy Geithner’s letter at the time to FSOC members urging them to step up oversight of money market mutual funds.
Irwin noted that the letter was “written in painstakingly formal language.” He translated Geithner’s message to the SEC this way: “Nice little industry you’ve got there. It would be a shame if something nasty happened to it, like having Federal Reserve examiners running around all the time questioning everything they do. You might want to ask your friends at the major banks, like Citigroup and Bank of America, how they enjoy that.”
Irwin mused, this was a “bit more thuggish than . . . (‘the Council’s authority to designate systemically important payment, clearing, or settlement activities under Title VIII of the Dodd-Frank Act could enable the application of heightened risk-management standards on an industry-wide basis’), but more accurate.”22
By involving FSOC where market regulators like the SEC and CFTC are outnumbered by bank regulators such as the Federal Reserve, the FDIC, and the Comptroller of the Currency, Schapiro risked ceding SEC authority to the bank regulators. Not only did this anger many SEC folks, but it also foreshadowed another big battle in 2013 when FSOC went for a takeover of most of the SEC’s functions regarding investment management.
I saw the dangers of FSOC and the Fed’s power in trying to take over control of investment management firms and brokers. The Fed and Treasury regulate banks that are obligated to take care of everyone’s money in the entire country, from the low-income retiree on social security to the hedge fund trader. Banks provide home and small business loans. They are a kind of financial public utility that isn’t expected to get in trouble, and they don’t pay huge returns on their CDs and savings accounts.
The FSOC was dominated by banking regulators who did not understand securities markets. The key to U.S. bank regulatory schemes is the “safety and soundness” of banks and their federally insured deposit accounts.* In contrast, the mission of the SEC is to “protect investors, facilitate orderly markets and promote capital formation.”23 For the banking regulators the object is the avoidance of risk, particularly for deposits. Since the Federal Deposit Insurance Corporation is the insurer for bank deposits, there is a federal interest in banks being sound to protect deposits.
The banking model is simply inapplicable to the model of risk capital in the securities markets regulated by the SEC. Investors come to markets to put their capital at risk as equity or debt investors in publicly listed companies in order to earn a return on that capital. The United States has created the most vital markets in the world through a regime based on the full and fair disclosure of all material facts about publicly traded companies and accurate presentation of accounting information on such companies. This regime proceeds from the fundamental premise that investors, armed with all the material facts, can make the best decision about where to invest based on their risk tolerance.
The U.S. securities markets are the envy of the world. I participated in the SEC’s “technical assistance” missions in Saudi Arabia, Abu Dhabi, and Hong Kong, where SEC personnel shared knowledge about U.S. securities markets and how the SEC regulates those markets and their participants. Those non-U.S. regulatory authorities around the world pay all the expenses for SEC personnel to travel to their countries so that they can learn from the country that has fostered markets that are transparent and reliable for investors seeking a return on their capital.
With this in mind, I knew the SEC couldn’t lose the right to write the rules on money market funds.
REBOOT
In early September 2012, I sat with Mary Schapiro at the conference table in her office. Mary told me how disappointed she was about the fracas over the money market fund proposal and even apologized that it had all gone so wrong right after I agreed to head up IM.
I told Mary that, despite the chaos, I felt that there could be a path to a compromise on money market fund reform. I asked her if she minded if I approached the commissioners to see if I could find common ground, and she encouraged me to do so. Mary noted that dialogue with the commissioners had broken down and she told me to give it a try.
About a week later, I was in my New York office, now on an old law firm floor with plenty of light that the New York region expanded into, when Craig Lewis called me to talk. Craig is a professor at Vanderbilt Business School who was on loan to the SEC as the chief economist. Craig and I talked for a long time that day. We had a feeling that a “floating NAV” coupled with “gates” allowing money market funds to suspend redemptions in a crisis could be a potential solution. The floating share price would restore market discipline to the funds, and the gates would let the funds stop redemptions if the funds still got in trouble—it was a good balance. With some tweaks, that is exactly what happened two years later.
Craig and I participated in a long road of meetings and talks with commissioners, FSOC staff, SEC staff, key staff in Congress, and industry people. Craig and I first sat down with each of the commissioners to see if our idea could be acceptable, and we received generally favorable responses. In November Craig completed the economic study of the 2010 reforms that Commissioners Aguilar, Gallagher, and Paredes had called for during the August tumult and posted it on the SEC website. I worked with the tremendous IM rule-making staff led by Diane Blizzard and Sarah ten Siethoff to develop a term sheet for a floating NAV–plus–gates proposal based on these meetings and the study. Chair Elisse Walter, who had succeeded Mary Schapiro, backed our efforts to find a compromise.
While we formed consensus in the SEC building, I had to go outside to several meetings of the FSOC principals and staff to explain where the rule-making process stood to fend off an FSOC takeover of the process. One such briefing occurred in the Diplomatic Reception Room at the Treasury with its elaborate mirrors and chandeliers standing in contrast to the jammed table and side chairs packed with principals and staff. At the same time we listened to industry representatives and activists talk about their views of what money market reform should look like, and we briefed staff on the Hill about where things stood. I walked a delicate line of reassuring all these groups that we were making progress but also not sharing any details of our compromise, as such information would undoubtedly leak out to the press and could upset the applecart at the SEC.
By the summer of 2013, Mary Jo White was the new chair of the SEC. She and the other commissioners approved the proposal 5–0, and we published it for public comment and further discussion with Congress and the industry. In the summer of 2014, we had two new commissioners, Michael Piwowar and Kara Stein, to replace Elisse Walter and Troy Paredes. Mike and Kara both voted against adopting the new rules, probably because they were new to this issue and didn’t want to take sides in a debate that had embarrassed many folks at the SEC. But White, Aguilar, and Gallagher did vote for it, and we got it done.
We ultimately did float the NAV—that is, apply the same rules to money market funds as other mutual funds and securities, meaning you can lose your money if the fund’s investments lost money. This allowed the daily share prices of funds to fluctuate along with changes in the market-based value of fund assets. We also provided money market fund boards with new tools—liquidity fees and redemption gates—to address runs.
Luis Aguilar wouldn’t vote for the package unless the fixed NAV—you put in a buck, you get at least a buck out—was preserved for funds that served retail investors. Since large institutional investors, not individual consumers, historically had rushed to pull their money out of these funds in 2008 and other times, I could live with it.
As was noted in the SEC’s press release on July 23, 2014:
With a floating NAV, institutional prime money market funds (including institutional municipal money market funds) are required to value their portfolio securities using market-based factors and sell and redeem shares based on a floating NAV. These funds no longer will be allowed to use the special pricing and valuation conventions that currently permit them to maintain a constant share price of $1.00. With liquidity fees and redemption gates, money market fund boards have the ability to impose fees and gates during periods of stress. The final rules also include enhanced diversification, disclosure and stress testing requirements, as well as updated reporting by money market funds and private funds that operate like money market funds.
The final rules provide a two-year transition period to enable both funds and investors time to fully adjust their systems, operations and investing practices.
Norm Champ, director of the SEC’s Division of Investment Management, said, “Today’s adoption of final money market fund reforms represents a significant additional step to address a key area of systemic risk identified during the financial crisis. These reforms are important both to investors who use money market funds as a cash management vehicle and to the corporations, financial institutions, municipalities and others that use them as a source of short-term funding.”
While this was a gratifying victory for American investors in 2014, few of them knew how close FSOC, the Frankensteinish superregulator designed by Dodd-Frank, nearly came the year before to taking the SEC’s place by staging a hostile takeover of the SEC’s role in regulating America’s mutual funds, investment advisers, and other investment management firms. Nothing would have been more disastrous for America’s economic growth and job creation. My tale of surviving that ordeal is in the next chapter.
*Under 12 USCA Sect. 1(a), the Office of the Comptroller of the Currency was established within the Department of the Treasury and “charged with assuring the safety and soundness of, and compliance with laws and regulations, fair access to financial services, and fair treatment of customers by, the institutions and other persons subject to its jurisdiction.”