Home > #OWS, finance, news > Money market regulation: a letter to Geithner and Schapiro from #OWS Occupy the SEC and Alternative Banking

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

November 6, 2012

#OWS working groups 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).

Here’s the letter, 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 5 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.

Categories: #OWS, finance, news
  1. jeff
    November 6, 2012 at 1:07 pm

    What is wrong with the first Shapiro proposal is that it would only solve a small part of the problem. People will still sell when the NAV drops because they feel their risk free investment has become a risky one and they will sell to achieve safety. (Note that the money fund crisis was precipitated because the NAV of one fund floated; even with floating NAVs money funds will generally stay at an NAV of $1.)

    The only way to deal with this is to establish some sort of insurance or equity buffer or both. However, the economics of money market funds really don’t support this.

    As a result the real alternatives are the following:

    1. Free insurance. This is what the government did in 2008. However, this is now prohibited as a result of lobbying by (small) banks. There is also the issue of moral hazard if this becomes a routine part of the infrastructure.

    2. No money market funds. This is kind of a destroy the village in order to save it option, which is unattractive. What one could perhaps do is prohibit the further growth of money market funds on the grounds that they are systemically dangerous. This would, over time, reduce the systemic risk.

    3. Leave things as they are. Have the fed ready to buy money market assets at par from any money market fund. (In other words,see item 1 above.)


    • November 6, 2012 at 1:10 pm

      First of all, there’s no difference between option 1 and 3- right now, the MMF’s are enjoying free insurance. Second, option 1 is not prohibited, since it’s still the operating procedure.

      But I don’t agree that Schapiro’s option 1 is unworkable- it just makes MMF’s less attractive because, duh, they are less attractive when taxpayers don’t back them. In other words, reality hurts.


      • Jeff
        November 6, 2012 at 4:57 pm

        I agree that there is no real difference between 1 and 3; thus the parenthetical with which I ended the post.

        The problem isn’t that Schapiro’s option 1 is unworkable; it is that it is ineffective. Also, note that allowing NAVs to float doesn’t preclude Fed intervention nor reduce the incentive to back MMFs in a crisis. It would make MMFs slightly less attractive for administrative reasons, but the fluctuations in NAV in normal environments are unlikely to be large enough to change the way people view MMFs.


  2. Jeff
    November 6, 2012 at 5:15 pm

    Apologies for the multiple comments. Would you have a link to the details of the FSOC proposal? Because the more I look at it, the more it looks like it would be far more effective than the Schapiro proposals, even the second (which is better than the first).

    Unlike Schapiro’s proposals it would appear to ensure the capital buffer was large enough to deal with any level of crisis and, presuming the underlying assets are good (which even in 2008 was generally the case), it would incentivize most MMF investors not to withdraw during a crisis (which short circuits the doom-loop of everybody running for the exits at once thus tanking the values of the underlying assets), with the incentive increasing as the crisis grew worse while not adversely impacting liquidity in normal times.


  3. G.Bailey
    November 6, 2012 at 8:06 pm

    I think this is the key flaw in your reasoning about the competing alternatives:

    ‘People will still sell when the NAV drops because they feel their risk free investment has become a risky one and they will sell to achieve safety’

    Fact is, under any of the proposals that basic fact doesn’t change, so there is no ‘problem’ that needs solving, other than clearly dislcosing to all MMfund account holders that their NAVs are not guaranteed not to lose principal. The floating NAV is the only one that confronts that basic fact head on. Guarantees, gates, loss sharing are merely mechanisms for dealing with the effects of the NAV actually falling below 1.00.

    Here’s Geithner’s letter

    Click to access Sec.Geithner.Letter.To.FSOC.pdf

    Here’s BlackRock’s proposal


  4. November 6, 2012 at 8:35 pm

    Way back in 2001 or so I read a book in which the author strongly recommended that people select a money market fund for their brokerage accounts which would be restricted to holding US Treasury certificates only. Great idea! No chance of toxic crap in the money market fund’s underlying portfolio! The only problem? I’ve never yet seen a brokerage offering such a choice to clients. Perhaps they exist. If the SEC were to mandate such a choice be made available, clients could choose: yield, or absolute security of principal. One teeny problem is that mmfs, like mutual funds, have expense ratios, sometimes higher than you might think. With an essentially nonexistent return, how can the mmf operator take out their daily piece of the action? These are for profit businesses, granted, and we have no right to expect free services, but really!


  5. Josh Snodgrass
    November 6, 2012 at 10:56 pm

    As usual, the devil is in the details. So, please accept the lengthiness of this reply.

    To be clear, there is no public FSOC proposal (see caveat in next comment). Geithner wrote a letter to FSOC that has a couple of vague sentences. However, those sentences have terms like “liquidity fees” that were not in the SEC proposals but are in the BLACKROCK proposal. Considering that BR proposal and Geithner’s letter mirrored that and other language we might suspect that is what Geithner has in mind. The FSOC as a whole has not voted (as far as we know, again, see my caveat below).

    The analysis in the letter focuses on Blackrock’s option 3 which is very likely the one the industry presented last week and probably was implicitly endorsed by Geithner in his letter.

    Before I get to the issues with BR Option 3, we need to understand one more thing Cathy didn’t mention. Currently the price at which you buy and sell is rounded to the nearest penny. So, if a fund has 1 million shares but its assets decline to $998,000, one share is now worth 0.9975 but if you sell you receive 1.00. If an institution owned 500,000 shares and sold them, they would bet $500,000 even though their pro rata share is only $499,000. Effectively, they take that extra $1000 from the remaining shareholders. If $1000 doesn’t seem like a big deal, remember that more realistic numbers are 10,000 these. One other important effect is that this drives down the share price.

    Now, to be clear, this problem existed in 2008 and exists today. There is a simple fix — simply calculate the share price with greater precision. But it was not mentioned in the SEC, FSOC or BR proposals. We will propose this to the SEC/FSOC when they finally get around to asking for public comment but they are only taking input from industry right now, but I digress.

    Now we can consider the issues with the Blackrock’s proposed option #3 (BR #3). The trigger would create an incentive for institutions to withdraw if they know (or suspect) that the value of the fund is near the trigger. There is an incentive for people to leave now but BR #3 would accelerate it. And, by withdrawing early, they would drive the price down over the trigger. That is the first problem.

    The second problem is that, as you note, BR #3 would then impose a penalty. This would likely stem or slow a run. But, it is at the cost of trapping the remaining shareholders in the fund. This penalty would be very big if we had a Lehman type event (even worse if a big European bank failed as a result of that crisis). So, these liquid funds would become very illiquid.

    Finally, it is likely that large institutions would be better able to track the situation and get out early. So, the less sophisticated will be taken advantage of.

    I would not say that the BR #3 is necessarily worse than the status quo (some of the letter’s authors would disagree. But we all agree that there are much better approaches.


  6. Josh Snodgrass
    November 6, 2012 at 11:37 pm

    FSOC says they want to be transparent. But they are transparent as mud.

    I suspect that the FSOC met in the past few days. I suspect that because the Sept. minutes are posted and to be approved they should have met. But we are left to speculate on this. There is no posting of whether a meeting has taken place or, if not, when the Nov. meeting it.

    More materially, at the meeting, Geithner has asked the staff to prepare proposals but, now that we can see the Sept. minutes,

    Click to access September%2028%20FSOC%20Meeting%20Minutes.pdf

    we see the FSOC as a whole did not vote to this effect. What is the process here? It is clear as mud.

    Much worse, we know there was a meetings with industry. Afterwards, industry representatives complained that the meetings became public. They said it was “counterproductive” to negotiations. That the discussions are sensitive. Treasury is negotiating with industry and Geithner is the one representing the public.

    The process is now becoming clearer. The plan is for industry to cut a deal with the Treasury. Then they will have ask for public comment that will be a mockery of a sham.

    If you read “Bull by the Horns” by Sheila Bair and “Payoff” by Neil Barofsky, you will realize it is an extremely bad idea to rely on Geithner to look out for the 99%.

    We need a voice in this process.


  7. bertie
    November 7, 2012 at 2:55 am

    So glad u guys r fighting for the downtrodden majority


  8. JJ
    November 12, 2012 at 11:13 pm

    Please let me simply say Thanks for all your hard work. I use “your” in the collective sense of Occupy the SEC & the Alternative Banking Group. You offer a real model of how “expertise” can be deployed in useful and progressive ways. Thanks.


  9. Josh
    November 13, 2012 at 4:46 pm

    Update: The FSOC met this afternoon and approved proposals.

    Notably, it appears they did not include the industry proposal as part of it (though I haven’t read all 73 pages.

    Now there will be an official comment round..


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