CONSEQUENCES OF FINANCIAL REFORM

Thank you to the Smith School of Business at the University of Maryland for having me on a panel at a conference about “The Intended and Unintended Consequences of Financial Reform” — at the Reagan Center in Washington.

Here is part of what I said.  As the FSOC and the Fed continue to look at the asset management industry as a potential source of “systemic risk,” I urge caution.  I am concerned that the well-documented problems of money market funds in the 2008 crisis are being used to argue that fixed income mutual funds are the new source of systemic risk.

The SEC’s foray into a fixed $1 per share money market funds did not hold up in the crisis.  Massive redemptions by institutional investors in money market funds in the fall of 2008 led to the Treasury guarantee program.  The SEC’s money market fund reforms in July 2014 addressed this issue by restoring the floating NAV to institutional money market funds.

It appears that attention is now focused on fixed income mutual funds.  There was a lot of discussion of how the increases in bank capital requirements have reduced lending by banks.  There is, of course, still demand for financing.  Some of this demand has migrated to mutual funds and there has been a large increase in mutual fund bank loan funds since 2009.  Mutual funds are a source of market based finance.  It was clear that there is concern about first mover advantage in these funds leading to a sell off in loans and a drop in markets.

Markets are prone to crowded trades.  This was true for Internet stocks in 2000 and Dutch tulip bulbs in the 1600s.  US markets are still the envy of the world and we need to make sure increased regulation does not change that.  Bank loan funds are not a large part of the $17 trillion mutual fund market.  These mutual funds also trade at an NAV that accounts for declines in value of portfolio holdings.

Mutual funds do vary in their attention to liquidity management.  In her December 11th speech, Chair White said that the SEC is working on a proposed rule regarding requirements for mutual funds to manage liquidity.  We should let the SEC manage this issue in the context of mutual fund regulation.

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