Remembering the Financial Crisis ... Or Not
Kurt Schacht, Managing Director, Standards & Advocacy, CFA Institute
How long is Wall Street’s memory? About a decade, it would seem.
This unscientific estimate is based on concerted efforts to roll back portions of the The Dodd–Frank Wall Street Reform and Consumer Protection Act. While Dodd-Frank rollbacks are the most visible evidence of fading memory, there’s other evidence too.
Specifically, I point to House Bill 2319, the Consumer Financial Choice and Capital Markets Protection Act of 2017 that would permit a stable NAV for institutional money funds and further exempt them from default liquidity fee requirements if they don’t invest 10% or more of total assets in short-term liquid assets. The bill offers some restraint with its prohibition against federal bailouts of money market funds, but in the main, it continues the persistent financial industry assault on systemic protections.
History Lesson
To understand how we arrived at this point, some reviewing of history is in order.
Rising defaults in subprime mortgages kicked off the global financial crisis in 2007, but it was a failure in money market mutual funds that was the one-two punch bringing the global capital markets to a halt nearly a year later.
According to a Federal Reserve Bank of New York study, over two dozen other money market funds would have, or technically did break the buck, but for sponsor support and rules that, unbelievably, enabled rounding of their NAVs to the nearest penny provided the appearance of stability.
The Treasury found the average loss among some 29 funds (including RPF) was 2.2%, with one reporting expected losses of nearly 10%. Perhaps even more troubling, without the supplementary measures noted above, several funds would have broken the buck even before Lehman Bros. filed for bankruptcy.
Push Forward Not Back
As noted some in the money market fund industry are now trying to unwind the safeguards implemented in 2016. Chief among such safeguards was the Securities and Exchange Commission adoption of new rules governing money market funds that required a floating net asset value (NAV) for institutional prime money market funds. This required the daily share prices of these funds to fluctuate along with changes in the value of the underlying fund assets, like any other mutual fund. In addition, new-fangled rules allowed money market fund boards new tools such as liquidity fees and redemption gates to help with extreme volatility and potential runs.
CFA Institute has long supported the fair-value accounting approach because it provides a truer reflection of economic value. Floating NAV is a prime example of this concept. When it comes to $2.7 trillion in money fund assets, the showing of assets at historical cost versus their true market value can be hugely systemic. Indeed, the RPF nearly brought down the house. The global financial system was on the brink, which could have been greatly mitigated had a more accurate valuation system been in place.
CFA Institute strongly supported the SEC’s proposal for floating NAVs for “prime” Institutional funds to limit redemption runs by large institutional investors. We reluctantly supported keeping stable NAVs for retail and government securities-based funds because neither proved systemic in 2008 and on the condition that they too would eventually move to a floating NAV regime.
Doing away with unproductive regulation because it was poorly designed or because it has become obsolete is one thing. Likewise, we fully agree that the Dodd-Frank Act deserves careful review and recalibration where needed after 6 years of experience. Clearly there are areas where regulation may have overshot, and more efficient, less costly options ought to be considered.
However, willfully making capital markets susceptible to the mayhem seen a decade ago by removing modest systemic risk protections is something entirely different.
Regardless of how it is structured or how it is packaged by proponents of lighter touch regulation, reintroducing stable NAVs for prime money market funds would be imprudent and systemically perilous.
If anything should change, it should be a move toward requiring floating NAVs for all money market funds in our view. The repercussions of the last financial crisis were all too real.
How soon we forget.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.