Matt Stoller is a fellow at the Roosevelt Institute. You can follow him at http://www.twitter.com/matthewstoller.
Proponents of Dodd-Frank have an incentive to argue the law is a tough crack-down on Wall Street. It’s a core part of Barack Obama’s narrative, that he bailed out the banks, but then did what FDR did in the 1930s with a series of tight regulations. Of course, it was immediately obvious that Dodd-Frank was an afterthought of the Bush/Obama administrations, that the real policy framework involved three key fights – the Fannie/Freddie bailouts under the Housing and Economic Recovery Act of 2008 (the so-called bazooka law), TARP, and the reappointment of Ben Bernanke. These fights were supplemented by Eric Holder’s decision to give legal forbearance to Wall Street executives, to not prosecute for rigging the CDO market or any number of illegalities in the foreclosure space.
After this radical consolidation of banking power in the hands of bailed out Too Big To Fail institutions, the Obama administration went to work on Dodd-Frank, which was essentially a 2000 page mash note to regulators saying “please don’t let that crisis happen again, it was awkward’. And now the evidence is beginning to trickle out that Dodd-Frank is a nothingburger. As Yves has already show regarding bank size and profits, Dodd-Frank, unlike TARP, is not particularly relevant to trends in the financial services industry. We will keep hammering on the flaws in Dodd-Frank as the opportunities arise.
One of the most egregious problems in the crisis were money market funds, which were large pools of money that funded the unstable repo market in the shadow banking system. Money market funds function effectively as uninsured bank accounts. And like uninsured bank accounts, they are prone to massive de facto bank runs, or withdrawals. There were two obvious solutions to this. One, treat them as bank accounts and force them to be insured and regulated. Two, treat them as non-bank securities and let their Net Asset Value (or NAV) float as the price of stocks or bonds do. Both of these would get rid of the risk of another bank run.
Of course, our bureaucratic elites did neither. SEC Chairman Mary Schapiro could not get a 3-2 majority on the commission to deal with this extremely basic and obvious problem. It’s a supreme embarrassment, and a possible reason Schapiro is leaving the SEC. It is so embarrassing that Tim Geithner is half-heartedly trying to get the giant committee of financial regulators – the Financial Stability Oversight Committee, or FSOC – to force movement on the issue. The way Geithner is doing it is by getting regulators to meet with the industry players like Blackrock behind closed doors first, and then solicit comment letters from the public after the regulations are effectively written. It doesn’t help his case that the rumors are thick he’s headed to Blackrock in a few months after his term as Treasury Secretary ends.
Occupy the SEC, Occupy Wall Street Alternative Banking, and a few others (such as Yves) have signed this letter preemptively describing the kinds of changes necessary to the money market industry, and preemptively warning Schapiro and Geithner that their ruse is obvious. It’s a well-done letter, and worth reading.
If this doesn’t get fixed, as I suspect it won’t, then Dodd-Frank will literally have done nothing about one of the core problems in the crisis of 2008 – the $4 trillion of uninsured bank run prone money market.
Two members of Occupy the SEC, George Bailey and Anchard Scott, provide additional background to this letter:
Discussions of the shadow banking system often focus on more exotic elements like hedge funds, collateralized debt obligations, and SIVs. But some of the largest shadow banks are money market funds, which collectively hold more than $6 trillion and are major funders for the commercial paper markets, which are an important source of short-term funding for major corporations, including financial firms, as well as certain types of bank off-balance-sheet vehicles. By investing in increasingly complex short-term funding markets, money market funds have connected the least sophisticated, highly safety-oriented investors to some of the most lightly regulated and tightly coupled collateral structures. The resulting combination is a recipe for instability in times of crisis, as we saw in 2007 and 2008.
One of the many gaps in the 2010 Dodd-Frank Act was its failure to deal with these risks. Although money market funds often function like some of the hybrid structures Dodd-Frank was meant to address – combining consumer banking features such as check books with active market portfolios – the Act left both money market funds and the short-term funding markets they invest in largely untouched. The only enhancement of regulation to date has been the 2010 reform of money market funds by the SEC, which tightened rule 2a-7 of the Investment Company Act to heighten liquidity by imposing basic constraints on money market fund portfolios.
Unfortunately, the 2010 reform left two significant gaps. First, it emphasized credit ratings as a primary metric of liquidity. A September 24 report from Fitch (hat tip Repowatch) cited this policy shift as a key driver of the continued increase in demand for repo agreements by money market funds. The risk of repos has been noted many times by this blog (for example, here and here) and in ECONNED, and remains an acute risk due to interlocking chains of exposures.
Equally important, the 2010 reform did little to control the shadow side of shadow banking – the potential for uncontrollable, destabilizing runs on thinly capitalized institutions. The SEC put forward two proposed measures earlier this year to address these risks, but was blocked by a combination of heavylobbying from the industry as well as a deciding vote by SEC Commissioner Luis Aguilar whose background included a stint as general counsel for a major money market fund sponsor. As one insider told the New York Times’ James Stewart: “It’s not Republicans versus Democrats. It’s the mutual fund industry and its allies versus the American taxpayer.”
That pattern appears to have driven the rulemaking process in the intervening months. As the letter below discusses, the FSOC has written policies committing it to transparency, but in this critically important and early action, is instead given the industry a first go, in secret, at money market rules, allowing the public to participate only after proposed language has been crafted to suit the incumbents’ needs. This procedure will result in industry-favoring draft language, which will be presented publicly as if it were a neutral starting point. Experienced regulators share our concern, that this procedure is a deliberate effort to stymie effective regulations of a known systemic hazard. Sheila Bair noted recently that “FSOC should not be a venue to relitigate and weaken needed reforms. It should be a mechanism for strengthening them.”
This letter is direct and well argued. I hope you’ll take a few minutes and read the full text.