Money market regulation: a letter to Geithner and Schapiro from #OWS Occupy the SEC and Alternative Banking

This is crossposted from by Cathy O’Neil. The opinions expressed here are hers and don’t necessarily represent a consensus view of the Alternative Banking working group.

Occupy the SEC and Alternative Banking have released an open letter to Timothy Geithner, Secretary of the U.S. Treasury, and Mary Schapiro, Chairman of the SEC, calling on them to put into place reasonable regulation of money market funds (MMF’s).

The letter is here, I’m super proud of it. If you don’t have enough context, I give a more background below.

What are MMFs?

Money market funds make up the overall money market, which is a way for banks and businesses to finance themselves with short-term debt. It sounds really boring, but as it turns out it’s a vital issue for the functioning of the financial system.

Really simply put, money market funds invest in things like short-term corporate debt (like 30-day GM debt) or bank debt (Goldman or Chase short-term debt) and stuff like that. Their investments also include deposits and U.S. bonds.

People like you and me can put our money into money market funds via our normal big banks like Bank of America. In face I was told by my BofA banker to do this around 2007. He said it’s like a savings account, only better. If you do invest in a MMF, you’re told how much over a dollar your investments are worth. The implicit assumption then is that you never actually lose money.

What happened in the crisis?

MMF’s were involved in some of the early warning signs of the financial crisis. In August and September 2007, there was a run on subprime-related asset backed commercial paper.

In 2008, some of the funds which had invested in short-term Lehman Brother’s debt had huge problems when Lehman went down, and they “broke the buck”. This caused wide-spread panic and a bunch of money market funds had people pulling money from them.

In order to avoid a run on the MMF’s, the U.S. stepped in and guaranteed that nobody would actually lose money. It was a perfect example of something we had to do at the time, because we would literally not have had a functioning financial system given how central the money markets were at the time, in financing the shadow banking system, but something we should have figured out how to improve on by now.

This is a huge issue and needs to be dealt with before the next crisis.

What happened in 2010?

In 2010, regulators put into place rules that tightened restrictions within a fund. Things like how much cash they had to have on hand (liquidity requirements) and how long the average duration of their investments could be. This helped address the problem of what happens within a given fund when investors take their money out of that fund.

What they didn’t do in 2010 was to control systemic issues, and in particular how to make the MMF’s robust to large-scale panic.

What about Schapiro’s two MMF proposals?

More recently, Mary Schapiro, Chairman of the SEC, made two proposals to address the systemic issues. In the first proposal, instead of having the NAV’s set at one dollar, everything is allowed to float, just like every other kind of mutual fund. The industry didn’t like it, claiming it would make MMF’s less attractive.

In the second proposal, Schapiro suggesting that MMF managers keep a buffer of capital and that a new, weird lagged way for people to remove their money from their MMF’s, namely if you want to withdraw your funds you’ll only get 97%, and later (after 30 days) you’ll get 3% if the market doesn’t take a loss. If it does take a loss, will get only part of that last 3%.

The goal of this was to distribute losses more evenly, and to give people pause in times of crisis from withdrawing too quickly and causing a bank-like run.

Unfortunately, both of Schapiro’s proposals didn’t get passed by the SEC Commissioners in August 2012 – it needed a majority vote, but they only got 2.

What happened when Geithner and Blackrock entered the picture?

The third, most recent proposal, comes out of the FSOC, a new meta-regulator, whose chair is Timothy Geithner. The guys proposed to the SEC in a letter dated September 27th that they should do something about money market regulation. Specifically, the FSOC letter suggests that either the SEC should go with one of Schapiro’s two ideas or a new third one.

The third one is again proposing a weird way for people to take their money out of a MMF, but this time it definitely benefits people who are “first movers”, in other words people who see a problem first and get the hell out. It depends on a parameter, called a trigger, which right now is set at 25 basis points (so 25 cents if you have $100 invested).

Specifically, if the value of the fund falls below 99.75, any withdrawal from that point on will be subject to a “withdrawal fee,” defined to be the distance between the fund’s level and 100. So if the fund is at 99.75, you have to pay a 25 cent fee and you only get out 99.50, whereas if the fund is at 99.76, you actually get out 100. So in other words, there’s an almost 50 cents difference at this critical value.

Is this third proposal really any better than either of Schapiro’s first two?

The industry and Timmy: bff’s?

Here’s something weird: on the same day the FSOC letter was published, BlackRock, which is a firm that does an enormous amount of money market managing and so stands to win or lose big on money market regulation, published an article in which they trashed Schapiro’s proposals and embellished this third one.

In other words, it looks like Geithner has been talking directly to Blackrock about how the money market regulation should be written.

In fact Geithner has seemingly invited industry insiders to talk to him at the Treasury. And now we have his proposal, which benefits insiders and also seems to have all of the unattractiveness that the other proposals had in terms of risks for normal people, i.e. non-insiders. That’s weird.

Update: in this Bloomberg article from yesterday (hat tip Matt Stoller), it looks like Geithner may be getting a fancy schmancy job at BlackRock after the election. Oh!

What’s wrong with simple?

Personally, and I say this as myself and not representing anyone else, I don’t see what’s wrong with Schapiro’s first proposal to keep the NAV floating. If there’s risk, investors should know about it, period, end of story. I don’t want the taxpayers on the hook for this kind of crap.