David Zaring is assistant professor of legal studies at the Wharton School of Business at the University of Pennsylvania.
Efforts to overhaul money market funds has posed not just a challenge to the Securities and Exchange Commission, which will finally vote on an overhaul package on June 5, but also to its new overseer, the supercommittee of agencies known as the Financial Stability Oversight Council, or FSOC.
The outcome of these efforts will tell us just how much on an overseer this supercommittee will be, which in turn will tell us something about how much the Dodd-Frank Wall Street Reform Act, which created FSOC, has, in fact, changed Wall Street.
A lot of blame for the depth of the financial panic in September 2008 can reasonably be laid at the door of the money market funds. The collapse of the Reserve Primary Fund - it broke the buck, which money market funds were designed and regulated to never do, on Sept. 16 of that year - led to the collapse of the entire asset class. Because money market funds were large purchasers of the commercial paper corporate America uses to finance its operations, that market ground to a halt as well, creating serious problems for the real economy.
In short order, the Federal Reserve found an obscure Depression-era statute (the Gold Reserve Act of 1934, if you’re keeping score at home), with an emergency fund attached to it, and used both to bail out the money market funds. It was good news for the economy, but a real stretch of the legal authority of the Fed. The S.E.C., which had nominally regulated money market funds, was entirely circumvented, and the Gold Reserve Act had never been used to bail out a domestic financial intermediary before.
Accordingly, Mary L. Schapiro, then the S.E.C. chairwoman, made the reregulation of money market funds one of her top priorities. She urged her agency to pass a rule that would let the funds have a floating net asset value, or N.A.V., that would move up or down from $1, reflecting the actual market value of the funds’ underlying portfolio holdings. Many financial experts and academics believe that a floating value would be refreshingly realistic. But the fund industry has opposed it vigorously, arguing that floating value funds would be difficult to sell to consumers.
The industry won over enough ears on the S.E.C. to prevent the agency from adopting Ms. Schapiro’s approach. So she and the then Treasury secretary, Timothy F. Geithner, turned to the Financial Stability Oversight Council to try to force the agency’s hand. The question is how, and whether it would be willing, to do that sort of forcing.
The Financial Stability Oversight Council has the power, under Section 120 of Dodd-Frank, to review and make recommendations related to a member agency’s regulation of a systemically significant sector of the financial system. Ms. Schapiro and Mr. Geithner successfully persuaded it to urge the S.E.C. to adopt a floating net asset value rule or to require money market funds to hold extra capital to deal with shocks.
But the problem with the council’s Section 120 powers is that they are not paired with the ability to force a member agency to act. If the S.E.C. does not want to regulate money market funds in the way the the council suggests, it need not do so. Under Section 120, it only has to provide an explanation to the council as to why it is not adhering to the council’s recommendation.
Moreover, the revised proposal before the commission would only introduce a floating N.A.V. for funds held by corporations and institutional investors, but not consumers, which arguably does not go as far as the Financial Stability Oversight Council,, and certainly some outside observers, would like.
Will that be enough for the council? Probably, but that is because it does not have many alternatives. The council’s stick lies in its Section 113 powers. Under that section, the body has the ability to regulate systemically important financial institutions and to designate such institutions, if they are not already banks, to be supervised by the Fed. It can make such a designation if it determines that material financial distress at the company or the nature, scope, size, scale, concentration, interconnectedness or mix of activities of the company could pose a threat to the financial stability of the United States.
The council has said, however, that it will only make such designations for companies that hold at least $50 billion in total consolidated assets.
So this is the final card that the Financial Stability Oversight Council has to play. If its recommendations on money market funds are ignored, it could designate the largest of those funds as systemically important and turn over the regulation of those institutions to the Fed. There might even be some advantages to doing so; while the S.E.C.’s regulatory rules have met with little success in the courts, the Fed has a much better record and reputation.
That of course, would be a turf battle that the S.E.C. would hate to lose, but it is also a drastic step. Will the council’s powers force the hand of the S.E.C.? Answering that question will tell us something about whether the jury-rigged committee of agencies that Dodd-Frank created to keep an eye on the safety and soundness of the financial system is more than some of its parts, or instead dependent upon those parts.
