Now that the SEC has reached an impasse on proposals to enhance the regulation of money market funds, the Financial Stability Oversight Council has a duty to impose heightened standards and safeguards for these funds.
The Council was created to identify threats to financial stability, and to take steps to eliminate them. It has specifically enumerated duties, which include an obligation to recommend that regulators strengthen standards when the firms that they supervise pose a threat to economic stability. It also has a duty to require that the Federal Reserve supervise and impose prudential standards on non-bank financial firms that pose threats to stability.
It is well known that money market funds helped to destabilize the U.S. financial system during the crisis. Although they are not federally insured, they are considered by some to be "safe." The funds are set up to mimic bank deposits. While the value of a fund depends on the market value of its assets, in normal times, shareholders are able to redeem their shares for a dollar.
But during the crisis it became clear that losses on money market assets could translate into losses for investors. When the Reserve Primary Fund "broke the buck," and told its investors that shares would not be redeemed for a dollar, corporations and institutional investors quickly created a run on other money funds.
Since money market funds are major buyers of commercial paper, and are significant lenders in the repo market, the operations of both markets were threatened because of the run. The threat was serious, and both the Fed and Treasury responded with emergency measures. The Fed set up the Asset-Backed Commercial Paper Money Market Funding Facility to prevent asset fire sales by the funds, and the Commercial Paper Funding Facility to support issuers of commercial paper. The Treasury allowed the funds to sign up for an "insurance" program, although the real guarantee came from the Treasury checkbook, and not risk-sharing by participating funds.
Since we have firm evidence that money market funds are vulnerable to runs and have contributed to market instability, the Council has an obvious duty to act. If it wants to work through the SEC, the Council has the authority to recommend that the SEC apply specific new safety standards to the funds. It could recommend, individually or in combination, any of the proposals already discussed by the SEC. Or it could impose more stringent requirements if they are judged necessary. The SEC can accept the recommendations, or say no and explain why within 90 days.
Making recommendations would give the SEC a second chance, but will not solve the stability problem if there aren't three commissioners who are willing to accept them.
The Council also has the authority to designate money market funds for supervision by the Fed, and recommend standards with which they must comply. This would require a two-thirds vote of the Council, including an affirmative vote by the Treasury Secretary, but it would resolve the issue.
This is the first real test of the Council. In my opinion, it has the opportunity and the authority to confront an important problem. It can show that it takes its mission seriously and is prepared to act. Or it can replicate the paralysis at the SEC. We will all be better off if the Council steps up.