A new Securities and Exchange Commission rule goes into effect Friday that can restrict investors from withdrawing their cash from the money-market funds that were at the heart of the 2008 financial crisis. If the G-20's international regulator (the Financial Stability Board) has anything to say about it then a similar rule will soon apply to the $16 trillion invested in all U.S. mutual funds. This would be a dangerous mistake.
The FSB's proposal is to charge investors' penalty fees if they try and sell their mutual-fund investment during a crisis and would even include a complete prohibition of such sales in extreme circumstances. It is expected to finalize its proposal later this year and then the SEC, U.S. Treasury and Federal Reserve are expected to promptly implement them in the U.S.
But there are several problems with the FSB's recommendation. First, runs on mutual funds have never caused a financial crisis, so it is unclear that further regulation is needed. Second, the FSB's proposal may actually exacerbate a crisis, because investors will try and pull their cash before the penalty fees or redemption restrictions apply.
The FSB has also failed to consider investors' response to the SEC's new rule for prime money market funds. In the last six months alone the money funds covered by the SEC's redemption restrictions have suffered almost $600 billion in total outflows and now manage only $150 billion in total assets. Even more withdrawals are expected.
These rapid withdrawals clearly show that investors want to avoid the SEC's money-fund rules and that expanding them to all mutual funds could drive significant outflows from the broader $16 trillion industry.