Back On The Road To Lehman? Two New SEC Proposals In Need Of Revision

A uniquely prescient Wall Street Journal op-ed by Eric S. Rosengren, President and CEO of the Boston Federal Reserve, recently addressed one of the key causes of the 2008 financial crisis – the run on prime money market funds that purchase corporate debt – caused by the (not always substantiated) FEAR that such funds were holding Lehman commercial paper and would therefore rapidly lose value due to the bank’s announcement of insolvency. Why do I say “prescient?” Because we could easily wind up watching a replay.

Clearly, 2008 had multiple “fathers.” Few dispute the overall complexity of the crisis. But today, one reality accepted by most of us who work in the financial world is that pure uncontrolled anxiety constituted one of the largest factors responsible for the now legendary Lehman-led liquidity crunch that quickly extended far beyond the financial sector. As Mr. Rosengren deftly explains, however, to date, the Treasury Department continues to struggle when it comes to reaching what could accurately be defined as a long-term “fix.” Instead, we got a set of emergency lending programs aimed only at supporting liquidity in the immediate wake of the specific 2008 crisis (most of which were subsequently dismantled under Dodd-Frank anyway…)

Now, five years later, while the SEC has at last thankfully begun the process of instituting permanent reforms, it nevertheless appears there’s a long way to go – certainly with this particular “piece of the puzzle.” Indeed, what’s now on the table might risk increasing the likelihood of future “cross-industry” liquidity crises. Mr. Rosengren is absolutely correct that the Commission’s current “reform” proposals require substantial revision and – in some instances – should probably be discarded altogether.

To begin, let’s take a look at where the SEC appears to be headed:

The first [reform], which the FSOC also supported, would treat money-market mutual funds like other mutual funds, allowing the value of a share to float with the value of the underlying assets. Investors run because they want to be the first one out of the fund if it looks like it’s about to break the buck and they won’t be able to redeem their shares at the $1 “fixed” price they expect. A floating price would let investors know all the time what the assets are worth. It would also mean that investors could not redeem their shares for more than the underlying value of the fund’s holding, which is the primary cause of runs in the current fixed price setup. This proposal was, by the way, supported by all 12 Federal Reserve Bank presidents in a comment letter sent to the SEC.

Although there is undoubtedly merit in providing investors a greater degree of transparency regarding the actual value of their assets and de-incentivizing investors from scrambling to grab “over-valued” redemptions, this first proposal falls short by covering only institutional prime funds rather than the far more prevalent retail funds, many of which also required direct government assistance in order to maintain liquidity during the 2008 crisis.

Then there is proposal #2: “[Allowing] fund directors to charge an investor for redeeming from a prime money-market fund, and in some cases allow a director to temporarily suspend an investor’s access to their funds for up to 30 days.

Here the problems ought to seem even more obvious – especially to experienced regulators. These proposed fees and suspensions would not only irrationally devalue assets but would simultaneously limit access to funds at the exact moment when liquidity is in shortest supply. As Mr. Rosengren notes: “The fear of fees and gates—just like the fears of runs—could lead to a self-fulfilling prophecy.(Hmmm… “Fear – Fear – Fear” — Didn’t these people learn anything from FDR’s First Inaugural Address???)

I, for one, heartily endorse the far better (below) concept put forth by Mr. Rosengren and sincerely hope the SEC and the Fed will take the necessary time to intellectually revisit 2008 before enacting policies that could force all of us to revisit those dark days in perpetuity:

The better solution would be to treat all prime money-market mutual funds, including retail funds, like other mutual funds that set aside no capital and take credit risk. The value of these funds should reflect an accurate appraisal of the underlying assets, not a fictitious fixed number.

Agreed 100%, sir.

Erecting artificial barriers and limiting information have never produced positive results in the past and there are no sound economic reasons to believe such measures would do so in the future. In contrast, a combination of greater transparency, accurate valuations and “fund equality” would offer significantly better odds of avoiding an analogous liquidity crunch whenever the next “Lehman moment” strikes.

Only in a truly warped universe could inventing new ways of repeating old crises somehow qualify as “reforming the financial system.”

Sadly, given our current state of dysfunctional government (and to be clear, I do fully recognize that the proverbial “buck” certainly doesn’t begin or stop with the SEC) this variety of warped thinking may indeed be just the latest manifestation of Washington DC’s “new normal . . .”

But if that is the case, then it’s even MORE unacceptable. I won’t accept it, the financial community won’t accept it, and – in the end – voters won’t either. Whether it’s creating a health care website that doesn’t crash, maintaining credibility in the Middle East OR effectively preventing future financial meltdowns, America quite obviously deserves far better from its “public servants.” 

Something to keep in mind the next time you’re wondering whether or not it’s still worth participating in the democratic process…

Trust me – IT IS.


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