Securities and Exchange Commission

SEC Money Market Fund Reform Proposals Fall Far Short, Again

As the principal regulator of U.S. money market mutual funds (MMMFs), the SEC has a duty to end the market distortions and moral hazard that repeated public rescues create. There have been two MMMF bailouts, so far. The first came at the height of the Great Financial Crisis of 2008, while the second followed in the March 2020 COVID crisis. While the Treasury provided guarantees only once, the Federal Reserve offered emergency liquidity assistance both times.

These repeated government interventions encourage MMMF managers to behave in ways that make future liquidity crises more likely. Moreover, there is no credible way for the Fed to promise not to intervene should a systemic disruption again loom in short-term funding markets. The only realistic means to end the subsidies created by the implicit promise of future bailouts is to force MMMFs to be far more resilient than they are today.

Against this background, the SEC’s December 2021 MMMF reform proposals are seriously disappointing. In this post, we start with basic facts about the scale and mix of MMMFs today. We then describe the SEC’s proposals, before focusing on their key shortcomings. We hope that the public comments that the SEC receives will motivate it, at the very least, to conduct a serious quantitative assessment of introducing capital requirements for the most vulnerable MMMFs, to re-assess the scale of additional liquid assets needed for MMMF resilience in the absence of a Fed backstop, and to propose ways to enhance the effectiveness and utility of MMMF stress tests….

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The Federal Home Loan Banks: Two Lessons in Regulatory Arbitrage

There is an important U.S. government-sponsored banking system that most people know nothing about. Created by an act of Congress in 1932, the Federal Home Loan Banks (FHLBs) issue bonds that investors perceive as having government backing, and then use the proceeds to make loans to their members: namely, 6,800 commercial banks, credit unions, insurance companies and savings associations. As the name suggests, the mission of the (currently 11) regional, cooperatively owned FHLBs is “to support mortgage lending and related community investment.” But, since the system was founded, its role as an intermediary has changed dramatically.

With assets of roughly $1 trillion, it turns out that the FHLBs—which operate mostly out of the public eye—have been an important source of regulatory arbitrage twice over the past decade. In the first episode—the 2007-09 financial crisis—they partly supplanted the role of the Federal Reserve as the lender of last resort. In the second, the FHLBs became intermediaries between a class of lenders (money market mutual funds) and borrowers (banks), following regulatory changes designed in part to alter the original relationship between these lenders and borrowers. The FHLBs’ new role creates an implicit federal guarantee that increases taxpayers’ risk of loss.

In this post, we highlight these episodes of regulatory arbitrage as unforeseen consequences of a complex financial system and regulatory framework, in combination with the malleability and opaqueness of the FHLB system.…

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Making Unelected Power Legitimate

Through what administrative means should a democratic society in an advanced economy implement regulation? In practice, democratic governments opt for a variety of solutions to this challenge. Historically, these approaches earned their legitimacy by allocating power to elected officials who make the laws or directly oversee their agents.

Increasingly, however, governments have chosen to implement policy through agencies with varying degrees of independence from both the legislature and the executive. Under what circumstances does it make sense in a democracy to delegate powers to the unelected officials of independent agencies (IA) who are shielded from political influence? How should those powers be allocated to ensure both legitimacy and sustainability?

These are the critical issues that Paul Tucker addresses in his ambitious and broad-ranging book, Unelected Power. In addition to suggesting areas where delegation has gone too far, Tucker highlights others—such as the maintenance of financial resilience (FR)—where agencies may be insufficiently shielded from political influence to ensure effective governance. His analysis raises important questions about the regulatory framework in the United States.

In this post, we discuss Tucker’s principles for delegating authority to an IA. A key premise—that we share with Tucker—is that better governance can help substitute where simple policy rules are insufficient for optimal decisions….

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