With less than a week to go in the SEC's Comment Period for its Proposed Money Market Fund Reform Rules the letters are beginning to stack up, and they should start coming in in droves as we approach the Sept. 17 deadline. The latest is a 21-page heavyweight critique from Melanie L. Fein of the Fein Law Offices, with a paper entitled, "The SEC's Money Market Fund Proposal: An Inappropriate Use of the Investment Company Act to Address a Bank Regulatory Problem." Fein writes, "The SEC's Proposal seeks to address a problem originating in the banking industry, not the MMF industry, and whose solution lies in banking regulation, not MMF regulation. The problem is one of excessive reliance on short-term credit to fund long-term assets by banks operating with insufficient capital, liquidity, or risk controls. That problem, combined with flawed bank credit underwriting standards, was at the root of the financial crisis. The problem must be addressed by banking regulators under the banking laws, not the SEC under the Investment Company Act."
She explains, "The Federal Reserve's insistence that the SEC impose drastic regulatory measures on MMFs is geared to shift the problem where it doesn't belong and subsidize the banking industry at the expense of MMFs and their investors. Statements by Fed officials indicate they want MMFs to serve as captive lenders to the commercial paper market in a crisis. The SEC's Proposal would do the Fed's bidding and place MMF shareholders at risk for the irresponsible behavior of large banking organizations. MMF shareholders would be held hostage to the emergency funding needs of institutions that banking supervisors have allowed to become too-big-to-fail and too-big-to-manage. The Proposal would force MMFs and their shareholders to prop up banks and the bank commercial paper market in a crisis -- a function that Congress intended to be performed by the nation's central bank, not MMFs and their investors."
Fein explains, "It is inappropriate for the SEC to pursue measures under the Investment Company Act that in reality are bank regulatory ambitions masquerading as MMF reforms. The Fed's proposals, embedded in the SEC's rulemaking, have serious implications for market efficiency and the future viability of MMFs, with uncertain long-term structural implications for the financial system as a whole. Rather than attempt to solve bank regulatory problems by subjecting MMFs to inappropriate regulatory actions, the SEC should abandon the Proposal. Instead, the SEC should recommend that the Fed and other banking regulators pursue supervisory measures to address systemic risks that arise when too-big-to-fail banks rely excessively on short-term credit to fund long-term assets with insufficient capital, liquidity, or risk controls."
She continues, "The Fed has said it currently is mulling over whether to seek public comment on possible approaches to address this problem, including by imposing an additional capital requirement on banks that rely excessively on the short-term markets. The SEC should encourage the Fed to pursue that process, which will address the problem directly, rather than adopt costly and unnecessary changes under the Investment Company Act that will harm MMF investors and have potentially disruptive and unpredictable consequences for the short-term credit markets."
Fein tells the SEC, "This paper argues that the problem the Proposal seeks to address is one not caused by either MMFs or deficient MMF regulation. Rather, the problem arises from a history of lax supervision of banking organizations by federal banking regulators who allowed banks to expand beyond traditional limits into complex financing activities without adequately understanding or supervising the risks they generated."
She says, "The problem has many manifestations but boils down to excessive reliance on short-term funding by banking organizations that operated with insufficient capital, liquidity, or supervisory oversight. These institutions used the short-term markets to sell high-risk loans made in violation of their own credit underwriting standards and disguised with credit ratings obtained by offering guarantees they could not realistically meet. The solution to the problem is not to emasculate the short-term credit markets by eviscerating MMFs but rather to impose appropriate limits on banks that access to those markets."
Fein adds, "The floating NAV and redemption penalties in the SEC's Proposal are unlikely to prevent heavy redemption activity by institutional prime MMF shareholders during a crisis. Indeed, they could have the opposite effect by encouraging investors to withdraw from MMFs precipitously to avoid the redemption penalties or a decline in portfolio value, thereby exacerbating the very problem sought to be averted."
Finally, she concludes, "Federal Reserve officials have said they are contemplating ways to deal with the problem directly, including by requiring banks that over-rely on short-term funding to maintain additional capital. The SEC should encourage the Federal Reserve to pursue that process rather than heed the central bank's unwarranted demands for drastic and costly regulatory changes to MMFs under the Investment Company Act. The Fed-inspired Proposal threatens to destroy an investment product valued by millions of investors and could have potentially disruptive and unpredictable consequences for the short-term credit markets."
