Last week, the SEC's Proposed Money Market Fund Reforms, which had been released in mid-December, were finally published in the Federal Register. This started the clock ticking on the 60-day comment period, so comments are now due by April 11. (See our Dec. 15 News, "SEC Proposes MMF Reforms: More Liquidity, No Gates/Fees, Swing Pricing and the SEC's press release here.) While to date there have been only a handful of legitimate comments (see the Comments on Money Market Fund Reforms here), a few serious responses continue to trickle in. The latest is from Norbert Michel from the Cato Institute, Center for Monetary and Financial Alternatives.
Michel's letter explains, "My name is Norbert Michel and I am the Vice President and Director at the Cato Institute's Center for Monetary and Financial Alternatives. I appreciate the opportunity to provide input to the Securities and Exchange Commission (SEC) for its proposed rule on money market funds (MMFs). The Cato Institute is a public policy research organization dedicated to the principles of individual liberty, limited government, free markets, and peace, and the Center for Monetary and Financial Alternatives [is dedicated to] identifying, studying, and promoting alternatives more conducive to a stable, flourishing, and free society. The opinions I express here are my own."
It says, "The rules that govern MMFs under the Investment Company Act of 1940 should be amended to improve the resilience and transparency of MMFs. To achieve such a goal, the amendments from 2010 and 2014 should be repealed. The Commission should finalize a rule that is more like the 1983 version of rule 2a-7 than it is to the current version."
The comment tells us, "The Commission's latest rule proposal partly acknowledges the failures of the previous MMF amendments, and the Commission deserves credit for recognizing those failures. Still, many of the same misguided views toward MMFs that drove many earlier rule amendments appears to be driving those in the new proposal. In 1981, for instance, Fed Chairman Paul Volcker testified before a Congressional committee that the Fed would prefer 'money market funds be subject to regulations that would make them more competitive with banking institutions and less attractive to investors.' Volcker proposed that Congress give MMFs reserve requirements, as well as rules that prevented investors from redeeming their shares on demand."
It states, "Even where it is no longer antagonistic, regulators have increasingly crafted rules to mitigate the supposed systemic risks of MMFs. Multiple government reports, in fact, justify these types of regulations by arguing that MMFs exhibited an inherent vulnerability to destabilizing runs during the 2008 crisis. Nonetheless, MMFs have displayed such an excellent safety record that many of these same government reports -- as well as other government agencies and research reports -- have had no choice but to acknowledge it. For example, a 2010 President's Working Group on Financial Markets (PWG) report acknowledges that in 'the twenty-seven years since the adoption of [the SEC's] rule 2a-7, only two MMFs have broken the buck. In 1994, a small MMF suffered a capital loss because of exposures to interest rate derivatives, but the event passed without significant repercussions.' The report also states that although 'the run on MMFs in 2008 is itself unique in the history of the industry, the events of 2008 underscored the susceptibility of MMFs to runs.'"
Michel writes, "Naturally, the uniqueness of the 2008 run suggests that MMFs are not inherently susceptible to such problems. Likewise, a 2010 Federal Reserve paper notes that from 'the introduction of the rules specifically governing these funds in 1983 until the Lehman bankruptcy in September 2008, only one small MMF lost money for investors,' and even though 'MMF prospectuses and advertisements must warn that 'it is possible to lose money by investing in the Fund', investors virtually never lost anything.'"
He continues, "Moreover, basic evidence from the 2008 crisis demonstrates that even the turmoil in the MMF sector during that period did not result in major losses for shareholders. Of the more than 800 MMFs that existed at the end of 2007, only one broke the buck during the crisis. In fact, shareholders of that fund -- the now infamous Reserve Primary Fund --ultimately received more than $0.98 cents on the dollar."
The letter states, "According to the conventional narrative, this success rate is only because the federal government stepped in to guarantee MMFs. A major problem with that theory, however, is that the Treasury guarantee program was never called on to cover any losses, a remarkable fact given that the program required participating funds to have a NAV greater than or equal to $0.995 and to liquidate if their share price fell by only one half of a percent. As reported in the Wall Street Journal, one reason for the success of that program was that 'the problems were relatively simple and contained,' because MMFs 'held high-quality and short-term assets, so the risk of guaranteeing them wasn't high for the government.'"
It continues, "Proponents of stricter MMF regulation also argue that because many fund sponsors stepped in to support their share values, typically by purchasing assets at par and waiting to resell them, the damage in the MMF industry was much worse than it appeared. A major problem with this argument, though, is that MMFs were explicitly designed with such sponsor support mechanisms in mind, meaning that they worked exactly as they were supposed to work. The truth is that it should be very rare for a MMF to ever return less than $1 per share to its shareholders, and indeed it has rarely happened. The overall evidence demonstrates that MMFs are not inherently unstable or vulnerable to destabilizing runs."
Michel also says, "More broadly, the view that MMF share redemptions cause market stress is fundamentally incorrect. Short-term capital flows through MMFs, meaning that share redemptions represent flows that occur in reaction to (among other things) market stress. There is virtually no evidence of MMF share redemptions causing stress or contagious runs on other credit markets, but a great deal of evidence linking those redemptions to (among other things) government-mandated rules and regulations, such as capital and liquidity requirements."
The letter's "Recommendations" tell us, "The MMF outflows in 2020 are just the latest example of prescriptively designed rules and regulations that fail to work as the designers intend. Just as decades of increasingly strict bank regulations have failed to produce financial stability, so too have increasingly strict MMF rules.... As a starting point for a new rule 2a-7, the Commission should use the 1983 regulatory framework for MMFs as a baseline. From there, the SEC should pare down the prescriptive rules to the bare minimum, so that they include little more than an average maturity restriction."
Finally, it adds, "Federal officials have repeatedly failed to design the stable and vibrant markets that they profess they can design. A less prescriptive regulatory framework for regulating MMFs will not guarantee a more stable financial system, but a highly prescriptive framework has already been proven to produce a fragile system. The Commission should admit that they cannot design vibrant capital markets that are always perfectly stable if they also want to allow investors to take the risks that create vibrant capital markets."
