Update: US’S Geithner to FSOC, Do MMF Reform Without SEC

–Updating Story Sent at 17:38 ET To Add ICI’s Reaction

By Denny Gulino and Yali N’Diaye

WASHINGTON (MNI) – On the eve of Friday’s meeting of the Financial
Stability Oversight Council of regulators, Chairman Tim Geithner told
members to prepare money market fund reforms even if the SEC remains
stymied on the issue, even designating the largest as subject to Fed
supervision if necessary.

In a letter to the Council’s member agencies, which includes the
SEC, the CFTC, the Federal Reserve and any others involved in financial
or markets supervision, Geithner said he is asking FSOC staff “to begin
drafting a formal recommendation immediately” to be voted on in
November.

Geithner’s letter to Council members follows a strong industry push
to stop SEC Chair Mary Schapiro’s effort to publish reform proposals,
with a necessary vote on the Commission balking at the effort, denying
the effort a majority.

SEC spokesman John Nester late Thursday told MNI, “The Chairman has
long believed that addressing the susceptibility of money market funds
to destabilizing runs is a critical piece of unfinished business from
the financial crisis. That is why,” he continued, “she has advocated for
reforms to bolster the structure of these funds. She is very pleased
that this important reform initiative is moving forward.”

The trade group that speaks for the mutual fund industry, the
Investment Company Institute, reiterated its opposition, promising to
continue its efforts against the adoption of such reforms.

In a statement sent to MNI late Thursday, ICI President and CEO
Paul Schott Stevens said, “As we have for more than four years, ICI will
continue to present empirical analysis to inform this regulatory debate,
in the hopes that regulators will take an objective fact-based view of
the issues.” He added, “The role that money market funds play in the
U.S. economy is far too important to proceed on any other basis.”

In late August, when Schapiro had to concede defeat, the ICI
repeated, “We have strongly opposed the structural changes to money
market funds under consideration at the SEC, because of the adverse
consequences of these proposals for investors, issuers and the economy.”

Stevens reiterated the argument on Thursday: “These proposals have
elicited strong opposition for their adverse impacts on investors,
issuers and the economy.” He also said, “Opponents include hundreds of
organizations across the nation as well as Members of Congress from both
parties.”

“Further reforms to the MMF industry are essential for financial
stability,” the Treasury secretary wrote to Council member agencies as
FSOC chairman. The Council, he said, has “both the responsibility and
the authority to take action to address risks to financial stability”
even if the SEC “fails to do so.”

Geithner said only Treasury’s guarantee of more than $3 trillion of
MMF shares, a series of liquidity programs by the Fed and support from
many mutual fund companies stopped panic withdrawals during the
financial crisis.

Geithner said he has “asked staff to begin drafting a formal
recommendation immediately” for publication after the November FSOC
meeting. An agenda for Friday’s FSOC meeting has not been disclosed but
it is expected to include consideration of non-bank financial
institution risk, and whether any large insurance funds should be
designated as systemically significant. It is a designation firms would
rather avoid if possible, since it can require expensive additional
safeguards such as additional precautionary reserves and frequent
reports, even on-site examinations, by regulatory authorities.

Geithner’s letter said FSOC should consider the same “SIFI”
designation for the largest money market mutual funds. “the Council
should closely evaluate the MMF industry to identify firms that meet
this standard” of posing a “threat to U.S. financial stability.”

Such a designation, he said, “would subject those firms to
supervision by the Federal Reserve and would give the Federal Reserve
board authority to impose enhanced prudential standards.”

Beside drafting reform proposals for comment, Geithner said FSOC’s
member regulators should seek industry input, engaging with “key
stakeholders” including MMF investors and customers to gather “informed
perspectives on the extent to which any mix of the specific reforms …
would achieve the same level of protection for investors and the broader
economy.”

Geithner said FSOC should work “in parallel” with the SEC and, in
any event, be prepared to go forward with MMF reforms if the SEC fails
to do so. The SEC’s Schapiro, in an op-ed published in the Wall Street
Journal a week ago, appeared to hold little hope of SEC action on the
issue and said it was up to FSOC to carry forward the battle against
heavy industry opposition.

Schapiro had hoped the swing vote on the Commission, Democrat Luis
Aguilar, would back her reform effort for the funds that hold $2.6
trillion. When Commissioner Luis Aguilar refused, she called it a
“tragedy” her proposals could not even reach the proposal stage.

Geithner, in his letter, said the formal proposal from FSOC later
in the year should include Schapiro’s two alternatives, either floating
the net asset values of the funds or requiring a capital buffer to
absorb fluctuations in the funds’ values. He added a third alternative,
imposing capital and “enhanced liquidity standards potentially coupled
with liquidity fees or temporary ‘gates’ on redemptions that may be
imposed as an alternative to a minimum balance requirement.”

By forcing the industry to pick its poison, FSOC would be taking
its first substantial steps to use its authority in a major industry
arena. The first eight firms it designated as systemically significant
were those that handle clearing and other transactional operations and
have little of their own funds at risk. None of the eight even used
their appeal opportunities and accepted the designations.

The insurance industry, which has some major players that might be
deemed eligible to be SIFIs has firmly opposed the possibility, saying
they are not posing any risk to the financial system. But the government
bailout of AIG, which surprised regulators by being at the center of
crisis risk, brought insurance companies into the universe of companies
that can imperil the system despite the fact they are not banks.

“Four years after the instability of MMFs contributed to the worst
financial crisis since the Great Depression,” Geithner wrote, with the
failure of the SEC to act, the Council should not move forward with the
tools provided by Congress.”

The susceptibility of the funds to panic withdrawlals was
demonstrated to government when, after Lehman Brothers failed, the $62
billion Reserve Primary Fund “broke the buck” as investors pulled their
money when it suddenly seemed to be at risk. More than $300 billion left
prime MMFs in a brief period of time and, Geithner noted, “Commercial
paper markets shut down for even the highest quality issuers.”

The funds have been considered to be low risk bank accounts,
particularly for other financial entities like hedge funds, offering
little in the way of yield but higher than bank accounts. But the crisis
revealed a key vulnerability, that the $1 per share valuation could not
be taken for granted.

As Geithner wrote, not only do the funds lack explicit
loss-absorption capacity, but in times of stress investors have an
incentive to get out quick while liquidity is still available.

Geithner took notice of the industry warning that clamping down on
the funds could move hundreds of billions of dollars into even less
regulatored sectors with even fewer protections, adding risk to the
system instead of reducing it. “Our objective,” he wrote, “should be to
propose reforms to MMFs that protect the stability of MMFs without
creating a competitive advantage for unregulated cash-management
products.

** MNI Washington Bureau: 202-371-2121 **

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