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Changes to Money Market Funds Stall

Attempts to make sweeping changes to a popular type of mutual fund that played a central role in the 2008 financial crisis have been derailed.

A security officer stands outside the U.S. Securities and Exchange Commission headquarters in Washington, D.C., U.S., on Tuesday, May 10, 2011.
Rich Clement | Bloomberg | Getty Images
A security officer stands outside the U.S. Securities and Exchange Commission headquarters in Washington, D.C., U.S., on Tuesday, May 10, 2011.

The chairwoman of the Securities and Exchange Commission(explain this), Mary L. Schapiro, wanted to bring her vision for regulating money-market mutual funds to a vote as early as next week. But Ms. Schapiro acknowledged Wednesday evening that three of the five commissioners opposed her plan and said she was calling off the vote.

While opposition was certain from the two Republican members of the commission, the crucial swing vote, a Democratic commissioner, Luis A. Aguilar, said in an interview on Wednesday afternoon that he would feel comfortable voting only after significant further study of the industry.

Ms. Schapiro wanted the $2.6 trillion money market fund sector to start holding cash reserves or to let their share prices fluctuate, instead of promising to pay investors $1 for every $1 they put in, among other changes.

After being informed of Mr. Aguilar’s comments, Ms. Schapiro said Wednesday evening that she had given up on trying to sway her colleagues. Her decision is at least a short-term victory for the financial industry, which has sunk millions of dollars into lobbying against her plan.

“It’s a tragedy that serious thoughtful proposals to shore up a major weakness in the financial system and protect American taxpayers from the potential need to bail out this industry can’t even receive public comment and debate,” Ms. Schapiro said in an interview.

Until the financial crisis, money market funds were considered a dull, low-return corner of the markets. But now, most of the nation’s top financial regulators view the sector as one of the most vulnerable parts of the American financial system.



The Federal Reserve and the Treasury Department, which supported Ms. Schapiro’s plan, had been preparing for the possibility that the financial industry might prevail in stopping the S.E.C. regulations. The officials have discussed the possibility of using new powers to move regulation of money market funds to the Federal Reserve, according to people with knowledge of their thinking.

Ms. Schapiro said that she would now support efforts by other regulators to force reform on the industry.

“The issue is too important to investors, to our economy and to taxpayers to put our head in the sand and wish it away,” Ms. Schapiro said.

Officials have not used the new powers that were delegated to a body of top regulators, the Financial Stability Oversight Council, by the 2010 Dodd-Frank financial regulation law. It is unclear what they could mandate and how long the process would take.

Ms. Schapiro had the support of one of the S.E.C.’s two Democratic commissioners, Elisse B. Walter. But Mr. Aguilar, who was formerly the general counsel for Invesco, an asset manager that operates money market funds, said Wednesday that Ms. Schapiro and the S.E.C. staff had not adequately studied the issue before pushing for a vote.

“There’s a lot that we know we don’t know,” said Mr. Aguilar, who had not talked about his views publicly for months. “It would make sense for us to get a handle on those before we do a proposal.”


One of the Republican commissioners who had previously stated his opposition to Ms. Shapiro’s proposal, Daniel M. Gallagher, said Wednesday that Ms. Schapiro and the S.E.C. staff had been unwilling to consider alternatives that he and others presented.

Ms. Schapiro said that she had seriously considered numerous proposals since the financial crisis, but had eventually decided it was time to act.

“This has been a very thoughtful and deliberative process that’s taken two and a half years,” said Ms. Schapiro. “When regulators identify problems and don’t speak up, you get financial crises. That’s why it was so important to speak up about this issue.”

Regulators view the funds as vulnerable because they act like banks by taking in money and promising to return every dollar that investors put in. Unlike banks, though, they don’t have to pay deposit insurance or keep capital buffers to protect against defaults.

The funds, which provide short-term loans to banks and other borrowers, grew wildly over the last 30 years because they typically offered a higher return than bank accounts and at their peak held $3.8 trillion.

Most investors have used the funds like low-risk bank accounts from which money could be immediately withdrawn.

Losses on $785 Million

But in the financial crisis the vulnerability of the funds was laid bare. In September 2008, the Reserve Primary Fund suffered losses on $785 million of debt issued by Lehman Brothers and fell below $1 a share, known as “breaking the buck.”

Investors fled the Reserve Primary Fund and a panic ensued in which they withdrew about $300 billion from money market funds in one week, contributing to the credit freeze that gripped global markets. The Federal Reserve and the Treasury Department stepped in to bail out the money market fund sector with a guarantee and a special loan facility.

The S.E.C. voted in 2010 to introduce several new rules aimed at making the funds more stable. The most significant change forced fund managers to hold more assets that could be easily sold for cash.

The financial industry has said in recent months that the 2010 rules were successful in improving the safety and soundness of the industry, making further reforms unnecessary.

But Ms. Schapiro and other regulators have frequently said that the 2010 rules were only a first step and that more significant changes are still needed. In late 2011, she presented two reforms that have remained at the center of her efforts since.

One would require the funds to stop pricing their shares at a stable $1 value and instead use a so-called floating net asset value. Critics of the $1 share value have said it leads investors to believe that the value of a fund’s holdings don’t fluctuate and that their money is guaranteed.

The other potential reform would require fund managers to put aside an insurance buffer of capital that could be used to absorb losses. This could also be combined with some restrictions on the amount of money that investors could withdraw.

Ms. Shapiro presented her reforms to the other four S.E.C. commissioners in June and had intended to hold a vote on Aug. 29 on whether to release the proposal for public comment. That would have come before a final vote on the rules.

Major fund managers including Fidelity, Federated and Charles Schwab have rallied allies to oppose Ms. Schapiro’s proposal. An industry group, the Investment Company Institute, said the supporters include 67 regional chambers of commerce, 105 House members and 10 state treasurers.

To counter the lobbying, leaders of the nation’s top financial regulatory agencies voted unanimously in July to support Ms. Schapiro’s ideas. Since then, the heads of several regional Federal Reserve banks have spoken publicly about the need for action.

Advocates of reform have said it is urgently necessary because the measures used to rescue the funds in 2008 were outlawed by the Dodd-Frank law. If the funds faced a run, regulators have said that they would have no way of stopping it.

“Money market funds effectively are operating without a net,” Ms. Schapiro said.

Mr. Aguilar and Mr. Gallagher both said on Wednesday that they are not opposed to further reforms. But they said that they worried that the rules proposed by Ms. Schapiro would cause many investors in the funds to immediately withdraw their money.

Mr. Gallagher said that the process of the Federal Reserve assuming oversight of the funds would take too long and was a “false threat.”

A spokeswoman for the Treasury Department, said Wednesday night that the funds still pose a risk to the financial system.

“This was a key source of stress during the financial crisis, and it must be addressed,” she said.

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