The Wall Street Journal is Right: Money Market Fund Rules Are Essential to Preventing Financial Crashes and Need to Be Stronger
One of the most consequential events during the 2008 financial crisis was when the Reserve Primary Fund “broke the buck” right after Lehman Brothers collapsed into bankruptcy. The result was a run on money market funds (MMF) which quickly had dire ripple effects throughout the financial system and in the real economy. To stop the run and the contagion, within days the Treasury backstopped the entire $3.7 trillion industry, putting taxpayers on the hook for losses. This was the single largest taxpayer-backed rescue program during the 2008 crisis and the largest the financial industry has ever received. (Don’t be misled by the fig leaf of an insurance program put in place after Treasury put the full faith and credit of the United States behind this one product.)
In response to these events, federal regulators implemented much needed and long-overdue reforms to reduce the run-risks posed by MMFs. The reforms required certain funds to float their NAVs (net asset value) to correctly reflect their actual market value and provided funds tools to mitigate run risk, including the authority to impose fees on those seeking to redeem quickly in times of stress and even the authority to halt redemptions entirely for a period of time.
While better than nothing, the reforms were insufficient and should have been stronger, as we argued for at the SEC at the time. In particular, all MMFs should be required to have market pricing and accurate NAVs. As The Wall Street Journal stated recently, “the idea is to show investors that MMFs aren’t risk-free and are investments with values that rise and fall.”
Allowing MMFs to report an artificial and incorrect stable price of $1.00 misleads investors into thinking that their MMFs are guaranteed and that they will always be able to withdraw a $1.00 for every $1.00 invested, i.e., MMFs will never “break the buck.” That belief is what causes the run-risk: once an investor thinks his or her MMF investment is at risk, the only rational reaction is to withdraw as quickly as possible, which causes everyone to run.
Nevertheless, as the mindless zeal to de-regulate gains momentum throughout Washington, even the modest MMF reforms are now under attack. Some are suggesting that the reforms should be replaced by risk disclosure. However, there is ample evidence that such disclosure is insufficient, including the specific disclosures by the Reserve Primary Fund and other MMFs in the years before 2008. There is no genuine dispute that disclosure is ineffective and, when combined with marketing and other materials, usually leaves investors confused at best and misled at worst.
Fortunately, new SEC Chairman Clayton is resisting efforts to roll back these reforms, believing that any changes would be, at best, premature. Recently, Better Markets wrote to him urging him to stay the course. The Wall Street Journal, in an editorial entitled “The Next Money-Fund Bailout,” also agrees that repealing these reforms would be a big mistake, although it went further: it agreed with Better Markets that “…the best way to avoid a bailout is to prevent a run by giving investors an accurate picture of market risks. A floating NAV is part of that crucial project.”
As we have also advocated for a long time, The Wall Street Journal emphasized the importance of “market discipline,” noting that MMFs “were never intended to be risk-free investments benefiting from taxpayer guarantees….” and that “the point of the floating-NAV reforms” is for investors to have a “more realistic assessment of risks.”
Instead of “Pushing the Envelope,” CFPB Acting Director Mulvaney is Mailing It In
Last week, CFPB Acting Director Mick Mulvaney issued a new mission statement to the CFPB staff outlining his vision for the agency.
He began by cherry-picking a quote from the previous director, Richard Cordray, about “pushing the envelope” to protect consumers from financial predators, which Mulvaney found frightening. He then ignored the CFPB’s statutory mandate and mission, disregarded the history of blatant predatory conduct that necessitated the creation of the CFPB and didn’t even mention the CFPB’s stellar track record of returning more than $12 billion to almost 29 million ripped off Americans.
Instead, he said the CFPB – the Consumer Financial Protection Bureau — works for “those who use credit cards, and those who provide those cards; those who take loans, and those who make them; those who buy cars, and those who sell them.” He’s essentially reading “consumer” out of consumer protection and putting in everyone, including those who are ripping off consumers!
Given that the CFPB is the only cop protecting consumers on the Wall Street beat, Mulvaney is like a chief of police. As such, it’s fair to ask, “What would Chief Mulvaney’s anti-crime plan look like to stop a crime wave (which is proved weekly by the headlines of the latest financial rip-offs)?” We detailed the answer to that question in an Op Ed, but here’s a few of his likely steps:
First, see if the criminals will stop on their own, i.e., self-police, even though they are getting rich ripping people off. Second, see if a group of criminals would join together to create a self-regulatory organization to monitor and stop themselves and their predatory behavior. Third, issue strongly worded press releases about being tough, hoping that will scare them, while at the same time asking the criminals for input on how the police department (i.e., CFPB) is or should be investigating them.
He’d likely take other steps (see the Op Ed here), but the last point is really important. Now, you might say, don’t be ridiculous. No one would ask the people they are investigating for wrongdoing to tell them how to conduct the investigation. However, that is exactly what acting director Mulvaney did last week: he asked for input from the “public,” which is overwhelmingly the industry, about how the CFPB should use its investigative powers. In essence, he is asking the industry how the CFPB should police them. That’s as naked a tell as can be.
But what acting director Mulvaney most wants the CFPB staff to remember is that, no matter how bad things get, never, ever “push the envelope” to protect ripped off consumers or get aggressive to stop the financial crime wave. And, never, ever forget to think about the financial criminals as much as the consumer victims.
Incorporating Several Key Issues Important to Investors, MD Financial Consumer Protection Commission Issues Report
Following public hearings where it received testimony from several experts, including Better Markets Legal Director and Securities Specialist Stephen Hall, the Maryland Financial Consumer Protection Commission issued its bipartisan Interim Recommendations, including several recommendations of importance to investors.
Created in response to the Trump Administration’s efforts to gut consumer protections, the Commission was tasked with providing recommendations for state and local actions to combat these efforts. Throughout its public hearings, it heard from experts on federal consumer financial protections, covering the Dodd-Frank Act and other vital financial protections. When Mr. Hall testified before the Commission, he discussed specific policies that are being pursued that pose a danger to consumers such as killing the Department of Labor’s fiduciary “best interest” rule and provided some strategies on how to fight back and resist these efforts.
The members of the Commission clearly heard what Mr. Hall had to say as its Interim Recommendations call for extending the fiduciary duty standard to all financial professionals providing investment advice and addresses forced arbitration clauses. The recommendations also include requiring credit reporting agencies to promptly alert consumers of data breaches, similar to Better Markets’ call for an Equifax Rule, requiring public companies to quickly disclose any significant computer hack.
