[House Hearing, 112 Congress]
[From the U.S. Government Publishing Office]
OVERSIGHT OF THE MUTUAL FUND
INDUSTRY: ENSURING MARKET STABILITY
AND INVESTOR CONFIDENCE
=======================================================================
HEARING
BEFORE THE
SUBCOMMITTEE ON CAPITAL MARKETS AND
GOVERNMENT SPONSORED ENTERPRISES
OF THE
COMMITTEE ON FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED TWELFTH CONGRESS
FIRST SESSION
__________
JUNE 24, 2011
__________
Printed for the use of the Committee on Financial Services
Serial No. 112-42
----------
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Washington, DC 20402-0001
HOUSE COMMITTEE ON FINANCIAL SERVICES
SPENCER BACHUS, Alabama, Chairman
JEB HENSARLING, Texas, Vice BARNEY FRANK, Massachusetts,
Chairman Ranking Member
PETER T. KING, New York MAXINE WATERS, California
EDWARD R. ROYCE, California CAROLYN B. MALONEY, New York
FRANK D. LUCAS, Oklahoma LUIS V. GUTIERREZ, Illinois
RON PAUL, Texas NYDIA M. VELAZQUEZ, New York
DONALD A. MANZULLO, Illinois MELVIN L. WATT, North Carolina
WALTER B. JONES, North Carolina GARY L. ACKERMAN, New York
JUDY BIGGERT, Illinois BRAD SHERMAN, California
GARY G. MILLER, California GREGORY W. MEEKS, New York
SHELLEY MOORE CAPITO, West Virginia MICHAEL E. CAPUANO, Massachusetts
SCOTT GARRETT, New Jersey RUBEN HINOJOSA, Texas
RANDY NEUGEBAUER, Texas WM. LACY CLAY, Missouri
PATRICK T. McHENRY, North Carolina CAROLYN McCARTHY, New York
JOHN CAMPBELL, California JOE BACA, California
MICHELE BACHMANN, Minnesota STEPHEN F. LYNCH, Massachusetts
THADDEUS G. McCOTTER, Michigan BRAD MILLER, North Carolina
KEVIN McCARTHY, California DAVID SCOTT, Georgia
STEVAN PEARCE, New Mexico AL GREEN, Texas
BILL POSEY, Florida EMANUEL CLEAVER, Missouri
MICHAEL G. FITZPATRICK, GWEN MOORE, Wisconsin
Pennsylvania KEITH ELLISON, Minnesota
LYNN A. WESTMORELAND, Georgia ED PERLMUTTER, Colorado
BLAINE LUETKEMEYER, Missouri JOE DONNELLY, Indiana
BILL HUIZENGA, Michigan ANDRE CARSON, Indiana
SEAN P. DUFFY, Wisconsin JAMES A. HIMES, Connecticut
NAN A. S. HAYWORTH, New York GARY C. PETERS, Michigan
JAMES B. RENACCI, Ohio JOHN C. CARNEY, Jr., Delaware
ROBERT HURT, Virginia
ROBERT J. DOLD, Illinois
DAVID SCHWEIKERT, Arizona
MICHAEL G. GRIMM, New York
FRANCISCO ``QUICO'' CANSECO, Texas
STEVE STIVERS, Ohio
STEPHEN LEE FINCHER, Tennessee
Larry C. Lavender, Chief of Staff
Subcommittee on Capital Markets and Government Sponsored Enterprises
SCOTT GARRETT, New Jersey, Chairman
DAVID SCHWEIKERT, Arizona, Vice MAXINE WATERS, California, Ranking
Chairman Member
PETER T. KING, New York GARY L. ACKERMAN, New York
EDWARD R. ROYCE, California BRAD SHERMAN, California
FRANK D. LUCAS, Oklahoma RUBEN HINOJOSA, Texas
DONALD A. MANZULLO, Illinois STEPHEN F. LYNCH, Massachusetts
JUDY BIGGERT, Illinois BRAD MILLER, North Carolina
JEB HENSARLING, Texas CAROLYN B. MALONEY, New York
RANDY NEUGEBAUER, Texas GWEN MOORE, Wisconsin
JOHN CAMPBELL, California ED PERLMUTTER, Colorado
THADDEUS G. McCOTTER, Michigan JOE DONNELLY, Indiana
KEVIN McCARTHY, California ANDRE CARSON, Indiana
STEVAN PEARCE, New Mexico JAMES A. HIMES, Connecticut
BILL POSEY, Florida GARY C. PETERS, Michigan
MICHAEL G. FITZPATRICK, AL GREEN, Texas
Pennsylvania KEITH ELLISON, Minnesota
NAN A. S. HAYWORTH, New York
ROBERT HURT, Virginia
MICHAEL G. GRIMM, New York
STEVE STIVERS, Ohio
ROBERT J. DOLD, Illinois
C O N T E N T S
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Page
Hearing held on:
June 24, 2011................................................ 1
Appendix:
June 24, 2011................................................ 47
WITNESSES
Friday, June 24, 2011
Bullard, Mercer E., President and Founder, Fund Democracy, Inc,
and Associate Professor of Law, University of Mississippi
School of Law.................................................. 9
Donohue, Andrew J., Partner, Morgan, Lewis & Bockius LLP......... 10
Goebel, Scott C., Senior Vice President and General Counsel,
Fidelity Management & Research Company......................... 12
Stam, Heidi, Managing Director and General Counsel, Vanguard..... 14
Stevens, Paul Schott, President and CEO, Investment Company
Institute (ICI)................................................ 7
Stulz, Rene M., Reese Chair of Banking and Monetary Economics,
and Director of the Dice Center for Research in Financial
Economics, Ohio State University............................... 16
APPENDIX
Prepared statements:
Bullard, Mercer E............................................ 48
Donohue, Andrew J............................................ 58
Goebel, Scott C.............................................. 69
Stam, Heidi.................................................. 89
Stevens, Paul Schott......................................... 106
Stulz, Rene M................................................ 205
Additional Material Submitted for the Record
Garrett, Hon. Scott:
Written statement of the Association of Commerce and Industry
(ACI)...................................................... 223
Written statement of the Association for Financial
Professionals (AFP)........................................ 226
Written statement of various undersigned organizations....... 229
Letter to Treasury Secretary Timothy F. Geithner from
Davenport & Company LLC.................................... 231
Written statement of the Dallas Regional Chamber (DRC)....... 232
Written statement of Financial Executives International (FEI) 233
Written statement of the Fort Worth Chamber of Commerce...... 235
Written statement of the Greater Boston Chamber of Commerce.. 237
Written statement of the National Association of Corporate
Treasurers (NACT).......................................... 239
Written statement of the New Jersey Business & Industry
Association................................................ 241
Written statement of the New Jersey Chamber of Commerce...... 243
Written statement of the New Jersey State League of
Municipalities............................................. 246
Written statement of the Chamber of Commerce of the United
States of America.......................................... 248
Maloney, Hon. Carolyn:
Financial Times article entitled, ``Don't hobble money market
funds,'' by Robert Pozen and Theresa Hamacher, dated June
19, 2011................................................... 250
Schweikert, Hon. David:
Written statement of Federated Investors, Inc................ 252
OVERSIGHT OF THE MUTUAL FUND
INDUSTRY: ENSURING MARKET STABILITY
AND INVESTOR CONFIDENCE
----------
Friday, June 24, 2011
U.S. House of Representatives,
Subcommittee on Capital Markets and
Government Sponsored Enterprises,
Washington, D.C.
The subcommittee met, pursuant to notice, at 9:34 a.m., in
room 2128, Rayburn House Office Building, Hon. Scott Garrett
[chairman of the subcommittee] presiding.
Members present: Representatives Garrett, Schweikert,
Royce, Manzullo, Biggert, Neugebauer, Pearce, Fitzpatrick,
Hayworth, Hurt, Grimm, Dold; Lynch, Miller of North Carolina,
Maloney, Perlmutter, Donnelly, Carson, Peters, and Green.
Also present: Representatives Renacci, Capuano, and Carney.
Chairman Garrett. Good morning. This hearing of the
Subcommittee on Capital Markets and GSEs is called to order.
And before I recognize myself to give opening statements, let
me welcome the panel and say a couple of housekeeping things.
We are going to do opening statements, and then, of course,
we will hear the witnesses' statements. We understand that near
the top of the hour, or a quarter after, or somewhere in there,
we are going to be called for votes.
And so, we do not know how many votes, but if it is only
one vote, then what we can probably do is just rotate through
and have you all keep on testifying as I just pop in and out,
and that sort of thing. We hope it goes that way.
If it is two votes, unfortunately, then we will probably
have to just take a brief 15- or 20-minute recess to allow us
all to go vote.
Okay. That is where we are.
I now recognize myself for 4 minutes. And, again, as I
said, welcome, everyone, to the hearing. We are here to explore
a series of issues impacting the mutual fund industry.
As you may know, it has been more than 6 years since this
committee last held a hearing focused on mutual funds. This new
Republican Majority has made it a priority to focus on
oversight, not only of government regulators, but also of
industries under its purview. Given that it has been over 6
years, this is a good opportunity now to reacquaint this
committee with issues affecting this industry.
There has been some attention in the media this week
regarding how the Greek debt crisis may affect money market
mutual funds. And while that is not why this hearing was
scheduled, it certainly is going to be a topic worthy of
exploring to some extent.
More broadly, though, there was the intent to focus today
on different efforts and proposals to provide more certainty to
policymakers, along with stability of the money market mutual
funds.
I do think the SEC's recent 2a-7 reforms make significant
progress in quelling systemic concerns about money market
funds. But I also think it is worth discussing today, different
ideas regarding potential so-called buffers for money funds.
As safe as money market funds generally have been,
unfortunately, the proverbial genie was let out of the bottle
back in 2008 when Treasury and the Fed stepped in to provide a
temporary guarantee program for money market funds, potentially
at the time putting taxpayers at risk.
So this type of action definitely needs to be avoided in
the future. And I think representatives of the industry on the
panel before me today would agree with that point of view.
As I said, I am interested in having a good discussion on
some of what has already been done by the SEC in the past and
what further could potentially be done going forward.
With all that being said, I have not been convinced that
the floating NAV is a proper avenue to go down in order to
address the perception by some that the money funds represent a
systemic risk. For one, I am not convinced that replacing a
stable NAV with a floating one solves the worry about runs on
the bank, so to speak, or runs on money market funds.
Additionally, policymakers must take into account the
impact that a floating NAV would have on the corporate and
governmental issuers of debt and our broader economy, as well.
There is compelling evidence that such an action would lead
to a loss of access to a significant source of short-term
funding. A floating NAV would also impact investors, basically
of all shapes and sizes.
And while I can understand some level of concern about
money market funds, we can also ignore the concerns about
banks, which is likely where much of that money now invested in
money market funds would migrate over to, if you institute a
floating NAV.
While on the one hand our money market funds were a source
of undeniable problems back in 2008, hundreds of banks have
failed in the last few years, and the TARP program pumped
literally hundreds of billions of dollars into banks during the
depth of the crisis.
So we cannot look at the potential victims of a floating
NAV in a vacuum. That would be, I think, at considerable cost.
Another issue I hope the subcommittee can explore today is
the potential for the Financial Stability Oversight Council
(FSOC) to designate asset management firms, such as mutual fund
companies, as systemically significant financial institutions,
or SIFIs.
With the way that Dodd-Frank requires regulators to
regulate SIFIs, there are a lot of questions as to how mutual
fund firms, for instance, would be regulated under a regime
largely set up, the same regime as the banks.
Furthermore, today's hearing may also touch on issues such
as the 12b-1 fees, the Dodd-Frank Act derivative rulemaking
issue and its impact on mutual funds, fiduciary standard
proposals, as well as proposed amendments to CFTC Rule 4.5.
But more than anything else, I hope today's hearing affords
us an opportunity to have a good and robust discussion on many
of the issues affecting the mutual fund industry today. So I
very much appreciate the panel being with us.
And with that, I turn--not to Ms. Waters--to Mr. Green for
2 minutes?
Mr. Green. Thank you. Thank you, Chairman Garrett.
And I also thank the full committee chairman, who is not
with us, but I thank him, as well. And, of course, the
Honorable Maxine Waters.
Mr. Chairman, I would like to commend you for holding this
hearing. It is an important hearing. And I thank the witnesses
for agreeing to participate.
You have indicated that it has been about 6 years since we
examined this topic in the committee, and I agree and concur
that it is time for us to have another opportunity to visit
these issues.
I am eager to understand how we can adapt regulatory
frameworks in governing the mutual money market funds such that
we can avoid a run similar to the one that we experienced in
the fall of 2008.
I understand that my constituents, and our constituents,
hold a lot of savings and retirement funds and accounts heavily
invested in money market mutual funds because of their safety.
And I want to ensure that future generations can continue to
depend on these financial instruments. They are important to
our economic stability, and they have been of great benefit to
us.
I am also interested in exploring the various options our
witnesses bring to the table today, including industry-funded
reserve buffers, a liquidity bank and two-tiered net asset
value--that is NAV--classes for money market funds.
Additionally, the recent economic climate in Europe has
raised some concerns over risk to U.S. money market funds. With
the knowledge that millions of Americans depend on stable
savings and retirement accounts, I am concerned about the
ramifications of a Greek debt crisis with regard to these
mutual funds.
This issue comes after particularly troubling times when
retirement savings have already been severely diminished by the
recent economic crisis.
Further, I would like to examine the potential for
individual mutual funds, or their managers, to be considered
systemically important. I am very interested to explore the
arguments for or against designating mutual funds as
systemically important, along with what the potential impacts
would be for both retail and institutional investors.
So with all these issues--and they are all important to
us--I am looking forward to this hearing, Mr. Chairman. I thank
you, and I yield back the balance of my time.
Chairman Garrett. The gentleman yields back.
And I understand that Mr. Capuano and Mr. Carney would also
like to participate in the hearing today.
Without objection, it is so ordered.
At this time, I yield 1\1/2\ minutes to the gentleman from
California, Mr. Royce.
Mr. Royce. Thank you, Chairman Garrett.
When we look back at 2008, you had very little exposure to
Lehman throughout the industry. But when Reserve Fund broke
that dollar, broke the buck, you had a massive run on prime
money market funds. And it really took some extraordinary steps
by the government to put a halt to that run.
And I think we have some questions here as to whether the
events in 2008 prove that the structure of money market funds
makes the industry today susceptible to that kind of a run.
That is up for interpretation.
What is not subject to interpretation, though, is that we
are now left with an industry that is at least implicitly
government-backed.
And given recent headlines, noting the potential exposure
of a European bank debt crisis, there are other questions that
are going to have to be kicked around in this committee.
We are going to have to ask, has the industry fundamentally
changed since then? Is it in a better position to prevent an
industry-wide run this time? Will the government be forced to
intervene again in such a circumstance?
But I hope that the hearing not only answers those
questions, at the end of the day, I think we have to remove the
perception that money market funds are risk-free or government-
backed. And I think reducing investors' incentives to redeem
shares from distressed funds is going to result in more stable
funds and a more stable financial system.
How that can be achieved is the subject of this hearing. We
have various competing ideas here that are going to be
presented to us in terms of the best way forward.
But I thank the chairman for holding this timely hearing. I
think that these are subjects that need to be resolved. And I
appreciate his leadership in trying to kick this off. Thank
you.
Chairman Garrett. And I thank the gentleman.
The gentleman from Massachusetts for 2 minutes.
Mr. Lynch. Thank you, Mr. Chairman.
I want to thank the witnesses for appearing before this
committee today and helping us with our work.
As of April of this year, the combined assets of the mutual
fund industry totaled about $12.5 trillion. From a systemic
risk perspective, it is important that regulation maintain
proper oversight of this industry.
It is also important to recognize that the money market
funds that have been noted in earlier remarks have been the
most stable sector of the mutual fund industry and represent
about $2.7 trillion within the industry.
However, everyone does remember, as the gentleman from
California mentioned, the event with the Reserve Fund breaking
the buck back in 2008.
But since that event, the SEC and other market participants
have studied the mutual fund industry, and significant reforms
have already been implemented in response to the Reserve Fund
event.
One of these measures, Rule 2a-7, imposes requirements for
asset quality and liquidity. The Commission has also reduced
the amount of money that market funds can invest in lower
quality, illiquid securities from 5 percent of a fund's assets
to 3 percent.
And the President's Working Group on Money Market Funds has
also proposed requiring money market funds to allow their net
asset value to float above or below $1 a share.
Now, the goal--the stated goal, at least--of the proposal
would be to help remove the perception that money market funds
are risk-free, and reduce investors' incentives to redeem
shares from so-called distressed funds that break the buck.
However, there is also countervailing evidence that allowing
NAV to float would also undermine the value of those assets.
I would like to hear the panel's opinions on that point,
how all of these reforms have affected the money market
industry, and particularly how a floating NAV proposal might
affect this financial tool, whether it would make it more or
less attractive to investors, and how it improves safety and
soundness.
But I want to thank you, Mr. Chairman, for your courtesy,
and I look forward to the testimony from our witnesses. And I
yield back.
Chairman Garrett. The gentleman yields back.
Mr. Dold for 1\1/2\ minutes.
Mr. Dold. Thank you, Mr. Chairman.
The mutual fund industry is a critical part of our economic
system, and, I would argue, one of the most important
investment vehicles millions of Americans use. With combined
assets now exceeding $12 trillion, millions of Americans rely
on the mutual fund industry for retirement funding, for college
tuition funding, and for growing personal resources.
Despite the mutual fund industry's vital importance to so
many Americans and to our economy as a whole, this committee
has not held an oversight hearing since 2005. And since that
last oversight hearing, we have seen the 2008 financial crisis,
the Dodd-Frank regulation, the resulting rulemaking process and
continuing dramatic industry growth, and so many other
developments that impact the industry.
So today's hearing is very timely and important, and I want
to thank the chairman for calling it.
I also look forward to hearing from our witnesses about
several specific topics, including fee reforms, potential FSOC
designations, corporate government reforms, and the SEC's
effectiveness in regulating the industry.
Most importantly, I am interested in how we might improve
the safety and stability of money market funds which now
contain assets approaching $3 trillion.
As we have learned from the Reserve Primary Fund during the
2008 financial crisis, there can be some risk to investors in
money market funds.
In that case, the Administration decided to expose
taxpayers to trillions of dollars of potential liability by
guaranteeing certain money market fund investments.
Fortunately, in that case, none of the guaranteed money
market funds actually failed. But we must ensure that taxpayers
are never again so badly exposed to such enormous potential
losses.
We all want smart and cost-effective regulation of the
mutual fund industry, and I look forward to hearing from the
witnesses about how we can get closer to that objective.
And I yield back.
Chairman Garrett. The gentleman yields back, thank you.
Mr. Carson for 3 minutes.
Mr. Carson. Thank you, Mr. Chairman. I want to thank the
chair and the ranking member for holding this hearing.
As the state of our financial markets and economy continue
to be of utmost concern, as we will be specifically focusing on
money market mutual funds today, I am very hopeful our
witnesses will explain why or why not these funds are good for
monies to be invested in.
I understand these funds do provide for short-term
financing for businesses, banks, and governments at all levels.
There is a certain stability, as well as convenience, that
these funds bring to the table.
While a few money market funds have broken the buck or have
gone below $1, the fund company or sponsor has stepped in to
absorb the losses.
I do, however, have concerns. I have some questions
regarding the net asset value and your opinions on money market
funds, assuming they float an NAV structure.
I am interested in learning about what this change could do
to not only the nature of a single investment vehicle, but also
what further implications and consequences these would have for
the entire system.
I also have some questions on whether or not these funds
could potentially be under some scrutiny for holding any Greek
debt or other euro zone investments. I am also curious as to
how the faltering billion-dollar Greek financial bailout
threatens the industry.
The money market fund industry has indeed, as you all know,
come under heightened scrutiny in the wake of the financial
crisis. It has brought to light concerns from both fund-
specific and systemic risks associated with these funds.
We are curious as to how we could distinguish these
different vehicles, from our distinguished panelists, and
really getting your insights and critiques and thoughts on an
issue that is within the regulatory system, really explaining
systemic risk without damaging money market mutual funds'
important role as a source of value to investors and funding to
the short-term capital markets.
Thank you, Mr. Chairman. I yield back.
Chairman Garrett. And the gentleman yields back.
I believe those are all the opening statements that we have
up here, so we will now turn to our esteemed panel.
And as you, of course, know, your full written testimony
has been already delivered to the committee. You are now
recognized for 5 minutes to summarize your statements.
Mr. Stevens?
STATEMENT OF PAUL SCHOTT STEVENS, PRESIDENT AND CEO, INVESTMENT
COMPANY INSTITUTE (ICI)
Mr. Stevens. Chairman Garrett, Congressman Green, and
members of the subcommittee, we welcome today's hearing because
of the central role that mutual funds and other registered
investment companies play in helping some 91 million Americans
achieve their most important long-term financial goals.
Today, the assets of these funds actually total some $13.8
trillion, representing nearly one-quarter of the financial
assets of U.S. households. As these figures suggest, the fund
market is vibrant and highly competitive.
One leading indicator of that competition is the cost of
fund investing. Since 1990, average fees and expenses paid by
mutual fund shareholders have decreased by more than half as a
percentage of assets for both stock and bond funds. Over the
same period, the range of services investors receive has
increased just as dramatically.
The key to the industry's success is the comprehensive
framework of regulation in which funds operate. That framework
grew out of the great financial crisis of the 1930s and has
proven its worth for over 7 decades.
Its distinctive features include market valuation of fund
assets each day, tight limits on leverage, unrivaled
transparency, strict custody of fund assets, detailed
prohibitions on transactions with affiliated parties, and
strong governance overseen by independent fund directors.
Fund regulation and our fiduciary culture helped ensure
that funds were not at the center of the latest crisis, nor
were funds the focus of the Dodd-Frank Act. Nonetheless, funds
and their advisers remain concerned about how the Financial
Stability Oversight Council will exercise its authority under
Dodd-Frank to designate non-bank financial institutions as
systemically important and subject them to heightened bank-type
regulation.
As we explain in detail in our written statement, funds are
already among the most highly regulated and transparent
financial companies in the country. They simply do not present
the kind or extent of risks to financial stability that would
merit SIFI designation.
Moreover, quite apart from designation, there is ample
regulatory power in Dodd-Frank and under other existing laws to
address risks identified by the FSOC or other regulators. And
regulators, in our view, should use those tools first.
Money market funds are a good case in point. Regulators not
only have the authority they need over these funds, they have
already put that authority to use.
After the financial crisis, our industry supported, and the
Securities and Exchange Commission adopted, comprehensive
amendments to its rules governing money market funds.
Those amendments raised standards for credit quality. They
shortened maturities. They improved disclosure. And for the
first time, they imposed explicit minimum daily and weekly
liquidity requirements.
As a result, prime funds today have a minimum of $660
billion in highly liquid assets available to meet redemptions
on a daily and weekly basis. This far exceeds the $370 billion
in outflows that we saw during the week of the Lehman Brothers
failure.
In short, we have come a long way in making money market
funds more resilient, and the industry remains open to ideas to
strengthen these funds further, including ways to enhance
liquidity and minimize the risks of a fund breaking a dollar.
Any further proposals, however, must preserve the utility
of money market funds to investors. They also must avoid
imposing costs that would make large numbers of additional
advisers unwilling or unable to continue to sponsor these
funds. Violating either of those two principles will undercut
the important role that money market funds play in our economy.
Bear in mind that these funds hold more than one-third of
all commercial paper issued by American companies and more than
half of all the short-term municipal debt outstanding. The
funding they provide is part of the life-blood of jobs and
communities, and in today's economy especially, we can ill
afford to disrupt it.
One disruptive idea is the notion of floating the value of
money market funds' shares, forcing these funds to abandon
their stable $1 per share price. Our investors, institutions
and individuals alike, have stated clearly that they cannot or
will not use funds that fluctuate in value for cash management
purposes.
And as Treasury Secretary Timothy Geithner recently noted,
any further changes to money market funds must be made
``without depriving the economy of the broader benefits that
those funds provide.''
We agree.
Lastly, let me note our concerns about conflict and
duplication that can arise when multiple regulators oversee the
same entities. One compelling example is the CFTC's sweeping
proposal to amend Rule 4.5 and potentially subject many
hundreds of mutual funds to regulations that duplicate or even
directly conflict with those of the SEC.
Why this is necessary, the CFTC has not adequately
explained, in our judgment. Nor is it clear why the CFTC wants
to so dramatically expand its regulatory reach now, when it
says to Congress it does not have enough resources to do its
basic job under Dodd-Frank.
This committee has addressed the need to promote regulatory
coordination and avoid market disruption by passing H.R. 1573.
ICI supports the policy goals of that regulation.
Mr. Chairman, members of the subcommittee, my written
testimony touches on a wide variety of other issues, any of
which I will be happy to discuss with you and your colleagues
during the question-and-answer session.
Thank you.
[The prepared statement of Mr. Stevens can be found on page
106 of the appendix.]
Chairman Garrett. Thank you very much.
From the University of Mississippi, Professor Bullard?
STATEMENT OF MERCER E. BULLARD, PRESIDENT AND FOUNDER, FUND
DEMOCRACY, INC, AND ASSOCIATE PROFESSOR OF LAW, UNIVERSITY OF
MISSISSIPPI SCHOOL OF LAW
Mr. Bullard. Thank you, Chairman Garrett, Congressman
Green, and members of the subcommittee. Thank you for the
opportunity to appear before you today.
Recent events have provided useful lessons in the
management of systemic risk, prudential regulation, and
investor protection in the mutual fund industry. The
performance of stock and bond mutual funds, for example, has
demonstrated the remarkable resiliency of the investment
company regulatory structure in times of extreme stress. As
share values have plummeted, most shareholders in mutual funds
have stood their ground.
This confidence in the investment company structure reduces
the likelihood of the kind of panic selling that contributes to
systemic risk. This is one of the reasons that true mutual
funds that price their shares based on their net asset value do
not pose material systemic risk and should not be treated, for
example, as systemically important financial institutions.
Another reason is that they are already comprehensively
regulated under the Federal securities laws by the SEC.
In contrast, money market funds are not true mutual funds.
They are not required to redeem their shares at the current net
asset value, or, more precisely, they are permitted to round
their net asset value to the nearest dollar.
Money market funds' stable net asset value can contribute
to systemic risk. And in the wake of the 2008 run on money
market funds, there can be no dispute that this risk is real.
The question before regulators is, what steps, if any,
should be taken to address this systemic risk?
Money market fund portfolios are safer than they were
before the crisis. They are better able to handle operational
and liquidity stress, and they are subject to improved
regulatory oversight.
But they were safe before the crisis. The 2008 run did not
result from shareholders' judgments about the safety of
individual funds in which they were invested. They made an
undiscriminating judgment about the safety of prime money
market funds as cash management vehicles.
Any regulatory reform that seeks to address this kind of
systemic run risk, therefore, must stand outside of the system
for which the reform is intended to provide a backstop. In
other words, it must retain the faith that the system it
supports has lost.
For example, capital requirements would operate within the
very system in which shareholders have lost faith. When it is
the system that shareholders doubt, safety mechanisms that are
viewed as operating within that system will not prevent a run.
The only meaningful preventive mechanism for systemic run risk
is a guarantee, like the Treasury's Temporary Guarantee
Program, that shareholders believe to be derived from an
external source.
The strongest source of such a guarantee is the full faith
and credit of the United States, as reflected by deposit
insurance. And it is my view that deposit insurance should be
extended to money market funds in conjunction with weaning
banks from investing insured deposits in anything other than
short-term assets.
However, deposit insurance is not necessarily the only
external guarantee that could provide an adequate source of
independent confidence. For example, a liquidity bank with
access to the Fed's discount window might be sufficient to
quell the doubts of institutional money market fund
shareholders who are likely to lead any money market fund run
in a crisis such as that experienced in 2008.
In contrast, requiring money market funds to effect
transactions at their net asset value--the so-called floating
NAV proposal--would not mitigate systemic risk. This would,
however, overrule the market preferences of tens of millions of
money market fund shareholders.
If the SEC's money market fund roundtable is any
indication, however, the preferences of these millions of small
investors in money market funds appear to be an afterthought.
In conclusion, I am also concerned regarding the SEC's
approach to being a prudential regulator. In January of 2008, I
filed a rulemaking petition with a group of similarly concerned
organizations to require money market funds to file their
portfolios with the SEC on a monthly basis, to enable detailed
monitoring of their portfolios.
This is what we wrote in that letter, 9 months before the
Reserve Funds broke a dollar: ``No retail fund has broken a
dollar, but we believe that it may be inevitable that a money
manager will one day decline to bail out its money market fund.
To prepare for this eventuality, the Commission should take
steps to ensure that the damage to faith in money market funds
is minimized.''
The Commission finally adopted this proposal years after we
submitted our petition, and I am concerned that it is not doing
what it should be doing with that data. In the last week, we
have seen headlines claiming that money market funds are
vulnerable to European exposure. I read in Wednesday's L.A.
Times that Federal Reserve Chairman Bernanke said that he is
keeping a ``close eye on money market funds.''
I found no public statements from the SEC on what it has
found, leaving the rest of us to wonder whether banking
regulators' repeated announcements that money market funds are
at risk may actually be true.
Being a prudential regulator means proactively, directly,
aggressively addressing concerns regarding the stability of
money market funds. I hope that the SEC will set the record
straight.
Thank you.
[The prepared statement of Mr. Bullard can be found on page
48 of the appendix.]
Chairman Garrett. Thank you.
Mr. Donohue?
STATEMENT OF ANDREW J. DONOHUE, PARTNER, MORGAN, LEWIS &
BOCKIUS LLP
Mr. Donohue. Thank you, Chairman Garrett, and members of
the subcommittee, for permitting me to testify before you.
My name is Andrew Donohue, and I am a partner at the law
firm of Morgan Lewis & Bockius, and I was Director of the
Division of Investment Management of the United States
Securities and Exchange Commission from May 2006 until November
of 2010.
Prior to joining the SEC, I held senior positions in the
investment company industry, most recently as global general
counsel for Merrill Lynch Investment Managers. I have been
associated with the investment company industry since 1975, and
I have recently been elected to the Board of the Mutual Fund
Directors Forum, a nonprofit organization of independent fund
directors.
The views I express today are my own and do not represent
those of my firm, my firm's clients or any other organization.
Funds are subject to a comprehensive regulatory regime that
has served fund investors well and played a significant role in
the success of the fund industry. With the critical role that
funds play in our economy and in the investment of American
people's hard-earned money for savings and retirement, it is
essential that this regulatory regime remain comprehensive, yet
flexible enough to meet changing markets and investor needs, as
well as to enable product innovation.
During the financial crisis, funds and their investors were
subject to many of the same challenges as other financial
institutions.
Funds performed quite well during this period with but a
few exceptions. A few short-term bond funds had exposures to
mortgage-backed securities that caused them to suffer
unexpected losses. A number of closed-end funds had issued
auction rate preferred securities that suffered auction
failures in 2008, resulting in those securities becoming
illiquid and losing value.
Money market funds had liquidity, pricing, and credit
issues that affected them during this period. The industry was
quite supportive of their money market funds, with over 25
advisers providing liquidity and other financial support to
over 100 money market funds.
While only one money market fund broke the buck, some
extraordinary steps were taken by the Treasury and the Federal
Reserve to stabilize this area.
Since then, the SEC has adopted amendments to its rules,
significantly strengthening the regulatory regime for money
market funds, and is currently considering additional measures.
I am confident that the SEC and industry participants will
be able to craft an approach that lessens the likelihood of a
run on money market funds or a money market fund breaking the
buck, while still preserving the benefits money market funds
have historically provided to investors and the markets.
While mutual funds and mutual fund complexes are important
participants in the U.S. financial system and provide many
benefits to their investors, I believe that the nature of
mutual funds, their operations, and the comprehensive
regulatory regime within which they operate, argue quite
forcefully for them not being considered systemically important
financial institutions.
Mutual funds have regulatory requirements on the degree of
leverage they can employ, the diversification and concentration
of their portfolios, where and under what circumstances their
assets are held, the valuation of their assets on a daily basis
at market value, the requisite liquidity of their investments,
and limits on transactions with affiliates.
These and other requirements have provided the sound
structure for funds to operate in, in a manner that does not
expose the U.S. financial system to the types of risk the Dodd-
Frank Act was concerned with.
For somewhat different reasons, I do not believe that asset
managers should be designated as significantly important
financial institutions. The asset management industry is quite
different from that of other financial institutions, and those
differences should militate against them being considered
significantly important financial institutions.
Asset managers do not put their balance sheet at risk, do
not guarantee returns, and their clients bear the risk of the
investments. The asset management industry is not concentrated,
and it is quite competitive, and assets can be moved quite
freely from manager to manager.
The SEC has played a critical role in the comprehensive
regulatory regime for funds. It has used the flexibility
provided in the Investment Company Act to adapt a 70-year-old
statute to changing markets and investor needs, and to
facilitate innovation in the fund industry, such as money
market funds and exchange traded funds.
It has also used that flexibility to permit funds to engage
in activities otherwise prohibited, by fashioning alternative
means of achieving the safeguards intended by the statute.
I want to thank you for the opportunity to testify today,
and I welcome any questions that you might have.
[The prepared statement of Mr. Donohue can be found on page
58 of the appendix.]
Chairman Garrett. Thank you.
And before you go, Mr. Goebel, I will just indicate to the
panel and the rest of the members here, we are just going to
continue. There is only one vote. It is on right now, so
members are encouraged to dash over to vote and then come back,
so that we will proceed as you are voting.
Mr. Goebel?
STATEMENT OF SCOTT C. GOEBEL, SENIOR VICE PRESIDENT AND GENERAL
COUNSEL, FIDELITY MANAGEMENT & RESEARCH COMPANY
Mr. Goebel. Chairman Garrett, members of the subcommittee,
thank you for the opportunity to testify today.
My name is Scott Goebel, and I am senior vice president and
general counsel of Fidelity Management and Research Company. In
this role, I am responsible for legal matters pertaining to
Fidelity's investment advisory businesses, including the
Fidelity mutual funds.
Fidelity Investments is one of the world's largest
providers of financial services, with assets under
administration of $3.7 trillion, including managed assets of
more than $1.6 trillion. We manage over 400 mutual funds across
a wide range of disciplines.
As you might have assumed, we are strong advocates for the
mutual fund model and the benefits mutual funds provide to
individual investors. Mutual funds allow shareholders, at a low
cost and for a small minimum investment, to obtain a
professionally managed, liquid, diversified portfolio of
securities, with the added safeguards of a robust regulatory
regime and independent board oversight.
For example, mutual funds operate under strict statutory
borrowing limits. And, as a result, the vast majority of mutual
funds do not use leverage to generate investment returns.
Today, there are more than 7,500 funds, holding over $12.5
trillion in assets, offered by a host of financial services
companies. We believe that these numbers illustrate the intense
competition and low barriers to entry that have been the
hallmarks of the mutual fund industry--forces that continue to
drive mutual funds to innovate and improve product offerings.
The assets in mutual funds belong to our shareholders. They
are not proprietary assets. They are not Fidelity's assets. And
our mission each day is to put the interests of our
shareholders first as we manage the assets of these funds.
I want to focus today in my oral testimony on money market
mutual funds. Money market funds offer a convenient way for
millions of investors and institutions to invest short-term
cash. For 40 years, they have offered stability, liquidity, and
income at a reasonable cost, and today provide an important
source of funding for State and Federal governments and
corporations.
In 2008, during the worst economic crisis since the Great
Depression, the credit markets became stressed as uncertainty
rippled through the financial markets.
As part of a broad range of efforts by the U.S. and foreign
governments to stabilize the markets, the U.S. Treasury
established a limited, fee-based insurance program to support
money market funds. No money market fund drew upon this
program, and the Federal Government actually earned $1.2
billion in fees.
At the height of the crisis in 2008, one money market fund,
the Reserve Primary Fund, dipped below the stable $1 per share
price that money markets strive to maintain.
In the aftermath of this financial meltdown, the SEC
adopted a comprehensive set of amendments to Rule 2a-7, which
have dramatically enhanced the resiliency of money market
funds.
To take just one example, the SEC rules now require that
each money fund be able to liquidate 10 percent of its assets
in 1 day, and 30 percent in 7 days. This change alone has
created, by one estimate, more than $800 billion of new
liquidity in money market funds.
The question is, what comes next? Are there additional
money market fund reforms that are necessary or appropriate?
Some reform options under consideration, such as the
floating NAV, would cause shareholders to leave money market
funds in large numbers. Based on client surveys, we believe
that these shareholders would shift to other investment
options, including banks, offshore products, and other
unregistered institutional investment options, all of which
pose greater systemic risks than do money market funds.
However, Fidelity understands that some Federal financial
regulators, and others, believe that more needs to be done to
increase the resiliency of money market funds. Therefore, we
are working with others in the industry on a proposal that
would strengthen money market funds by creating a buffer within
each fund.
It is worth noting that this is a private market solution
that does not rely on any government support.
The idea is pretty simple. Each fund would be required to
hold back a portion of the yield shareholders would otherwise
receive. And this amount would grow over time to create a
buffer, or cushion, that would help absorb any potential losses
and help ensure liquidity by enabling money market funds to
sell securities at a loss to meet large redemptions.
Shareholders would continue to buy and sell shares at the
$1 price, but each share would represent assets of slightly
more than $1.
We arrived at this solution by asking ourselves, what is
the problem that regulators are trying to solve? By and large,
we believe that the issue is that some shareholders have--or
think they have--an incentive to redeem first, in order to
avoid paying for a portion of a potential loss in a money
market fund.
The NAV buffer concept eliminates this incentive to get out
first, because as shareholders redeem, the buffer amount is
spread over a smaller investor base. In other words, a
shareholder redeems $1, and leaves the value of the buffer
behind in the fund, which helps to protect the remaining
shareholders.
As regulators in the industry consider additional possible
reforms, we submit that the question should not be, how do we
prevent the next money market fund from breaking a buck;
rather, the question should be, since so much has already been
done to improve the resiliency of money market funds, how can
we alter shareholder incentives to ensure that, if a money
market fund breaks a buck in the future, shareholders and other
funds are not affected.
I would like to thank the subcommittee and staff for their
work on these issues that are important to mutual funds and our
investors, and for holding this hearing.
I would be happy to answer any questions.
[The prepared statement of Mr. Goebel can be found on page
69 of the appendix.]
Chairman Garrett. And I thank you.
Ms. Stam, please, for 5 minutes?
STATEMENT OF HEIDI STAM, MANAGING DIRECTOR AND GENERAL COUNSEL,
VANGUARD
Ms. Stam. Thank you.
Thank you, Chairman Garrett, and members of the
subcommittee. I appreciate being here today.
My name is Heidi Stam, and I am a managing director and
general counsel of Vanguard and the Vanguard Mutual Funds.
Vanguard is one of the world's largest mutual fund firms.
We offer more than 170 mutual funds with combined assets of
approximately $1.7 trillion. We serve nearly 10 million
shareholders.
About 95 percent of the assets we oversee are owned by
individuals, whether they invest directly with Vanguard,
indirectly through financial advisers, or as participants in
retirement funds.
In short, we are a big company that serves many, many small
investors.
We appreciate your interest in Vanguard's views about the
current state of the mutual fund industry, and we hope to lend
to this hearing the perspective of the average investor from
Main Street, not Wall Street.
During the financial crisis, investor trust and confidence
in the global financial system was severely damaged. Investor
trust and confidence in mutual funds, however, was not. And
this is a very important distinction.
Indeed, assets entrusted to mutual funds and ETFs reached
an all-time high of nearly $13 trillion at the end of last
year. This is a tremendous testament to the trust that millions
of investors place--and have placed over many decades--in
mutual funds.
Mutual funds are resilient. They have weathered every
crisis from the Great Depression of yesteryear to the great
recession of yesterday.
Mutual funds are the most efficient, effective, and
intelligent way to invest in the securities markets. Compared
to other financial products, they provide superior liquidity,
transparency, professional management, and diversification--all
at a reasonable cost.
We believe that strict regulatory oversight of mutual funds
has played a vital role in their success. Mutual funds are
subject to a comprehensive regulatory regime. And for more than
70 years, the SEC and the industry have shared an obligation to
serve and protect the interest of investors. It is an
obligation we do not take lightly.
This shared obligation came to the fore in 2008, when the
money markets were rattled by the most significant liquidity
crisis in our history. The industry and the SEC moved to solve
the problem quickly and thoughtfully.
The industry formed a working group which began a thorough
review of rules governing money market funds, and they
developed a series of measures to address the funds' ability to
withstand the extremely unusual market conditions that existed
at the time.
Shortly thereafter, the SEC adopted enhancements to Rule
2a-7, which improved the liquidity, credit quality, maturity,
and transparency of money market funds.
We believe that these enhancements addressed the need for
greater liquidity in money market funds and significantly
reduced the risk that a future systemic market disruption would
threaten the liquidity of these funds.
If the SEC determines, however, that additional measures
are needed, then we would encourage a solution that is tailored
to address the remaining concern.
Specifically, more liquidity may be required for
institutional money market funds that have demonstrated a
heightened need to make large, same-day redemptions. And we
think this could be achieved quite simply by increasing the
liquidity requirements for these funds.
This approach, or other recent proposals that are discussed
here today, are simply not required for mom-and-pop money
market funds. The cost, complexity, and disruption that
additional changes may cause small retail investors are not
warranted, given the way these money market funds are used--to
pay the mortgage, send a tuition check, or save for a rainy
day.
We believe money market funds are well regulated and should
remain solely under the SEC's jurisdiction. That said, Vanguard
understands the need for the Financial Stability Oversight
Council to monitor risk across markets, institutions, and
segments.
It is important to emphasize, though, that none of the
reckless lending, leveraging or financial engineering that led
to the creation of FSOC related to mutual funds.
Mutual funds do not have leverage exposures or off-balance
sheet liabilities. They mark their asset value to market every
day. Their portfolio holdings are transparent and reported
regularly.
Mutual funds do not engage in proprietary trading. They do
not pose systemic risk. They do not have the attributes of
systemically important financial institutions, based on the
FSOC factors, and they should not be designated as such.
Vanguard has always been willing to discuss the interest of
mutual fund investors with legislators and regulators. We
respectfully caution against duplicative regulation that has
the potential to limit innovation, raise the cost of investing,
stretch the resources and time of fiscal constraint--unless
there are clear benefits to investors.
We believe that mutual funds already benefit from multiple
layers of investor protection in the form of strong securities
laws, an effective regulatory agency, a keenly competitive
industry, an educated consumer, and a vigilant news media.
Thank you very much for this opportunity to share our
views. We would be happy to answer any questions.
[The prepared statement of Ms. Stam can be found on page 89
of the appendix.]
Chairman Garrett. Thank you, Ms. Stam.
Professor Stulz?
STATEMENT OF RENE M. STULZ, REESE CHAIR OF BANKING AND MONETARY
ECONOMICS, AND DIRECTOR OF THE DICE CENTER FOR RESEARCH IN
FINANCIAL ECONOMICS, OHIO STATE UNIVERSITY
Mr. Stulz. Chairman Garrett and members of the
subcommittee, I thank you for giving me the opportunity to
testify at this hearing.
My name is Rene Stulz. I am a professor at the Fisher
College of Business of the Ohio State University.
Systemic risk is used everywhere, all the time within the
regulatory community. At the same time, it is rarely defined
and almost never quantified, which makes possible a lot of
mischief.
My definition of systemic risk is that it is the risk that
the financial system becomes incapable of performing one or
more of its key functions in a way that prevents normal
economic activity.
To justify regulation in the name of preventing systemic
risk, it is important to assess both the costs and the benefits
of that regulation. Any systemic designation should be based on
objective and quantifiable criteria.
On economic grounds, there is no reason to believe the
specific mutual funds, mutual fund complexes or management
companies should be designated as systemically important.
The asset management industry plays a critical role in our
economy by managing the funds of investors. The failure of a
player in that industry in performing its role does not create
a systemic risk. If one player runs into trouble, another
player can take its place.
There is no evidence that the asset management industry
created systemic risk during the recent crisis, except in one
segment: the money market fund segment.
Rather than designating money market funds as systemically
important, it would make more sense to eliminate the features
of money market funds that create systemic risk.
By their very nature, money market funds are prone to runs.
When investors run from funds, this forces funds to sell assets
and disrupts the provision of short-term funding in the
financial system.
In 2008, the run was started by losses on Lehman
investments at one fund, the Reserve Primary Fund, which was
forced to redeem shares at less than $1.
In the 2 weeks following the bankruptcy of Lehman, more
than $400 billion left prime money market funds. Further, money
market funds sold assets to become more liquid to cope with
further redemptions. Runs and anticipated redemptions led to
chaos in the commercial paper market as well as in the repo
market.
The point of reform of money market funds is not,
therefore, to make investors in these funds safer; it has to be
to make the financial system safer.
Some might argue that reforms that have already taken place
have eliminated the problem. This is not correct. Money market
funds are still vulnerable to runs.
Further, the large positions of the funds in European banks
are a source of risk for these funds, as well as for the
financial system. A recent study finds that the top 15 largest
prime AAA funds have more than 50 percent of their assets
invested in foreign banks--the lion's share of these
investments in European banks.
The key reason why money market funds are prone to runs is
that they allow investors to redeem at $1, when the market
value of the fund's assets is worth less than $1. If the market
value of a fund's assets is worth less than $1 a share, it can
become rational for investors to run, since they receive $1 by
redeeming immediately, instead of possibly receiving less if
they do not.
To make runs much less likely, the Squam Lake Group, a
group of 14 economists of which I am a member, has proposed
that the money market funds either should have a floating NAV,
or should have a buffer that could be used to prevent the NAV
from falling below $1 a share.
By buffer, we mean resources committed by the management
company, or by third parties, that absorb losses, so that the
fund can keep redeeming shares at $1, even if it has made
losses. The use of a buffer makes it possible to keep the
stable value NAV mechanism, but largely eliminates the
incentives for investors to run, since the buffer ensures that
the mark-to-market value of the shares does not fall below $1,
as long as the buffer is large enough to cover losses.
We proposed several mechanisms to create a buffer.
Irrespective of how the buffer is implemented, we recommend
that any buffer mechanism should have three important
characteristics.
First, the mechanism should be such that, in the presence
of losses, the buffer could be replenished quickly.
Second, a stable value fund should immediately convert to a
floating NAV fund if the buffer is depleted, so that its value
is below some minimum threshold.
Third, once losses have been made, the buffer should be
replenished within a short period of time; and if it is not,
the fund should convert to a floating NAV fund.
Thank you again, Mr. Chairman and committee members, for
letting me testify. I would be happy to answer any questions.
[The prepared statement of Mr. Stulz can be found on page
205 of the appendix.]
Mr. Schweikert. [presiding]. Thank you, Mr. Stulz.
As a matter of fact, you are all very impressive. It is
amazing how close you all came to hitting exactly the 5 minute-
mark.
A couple of odds and ends. One, I just finished, earlier
this morning, reading something from the Federated Investors. I
would like to actually put that into the record.
And the Chair yields himself 5 minutes.
I would like to actually continue where you were going,
Professor Stulz, regarding what you call a buffer. If an
account or fund puts that buffer, what has that done to its
yield?
Mr. Stulz. In the Squam Lake proposal, which is appended to
my written testimony, we try to estimate the impact on the
yield. And our conclusion is that the impact would be minimal.
What would happen is that the funds would have incentives to be
very transparent about the holdings.
Mr. Schweikert. My concern was actually--and I was actually
going through your proposal this morning--I was trying to get
some understanding. Particularly, I come from having once been
an institutional investor in these types of accounts, and just
managing lots and lots of cash.
Sometimes, I could only hold them for 45 days until I had
to pay salaries for teachers or sheriff's deputies. But that
yield sometimes was the salary for another teacher. And so, I
am always very, very yield-centric, if that buffer does much
damage on that rate of return.
Mr. Stulz. Our conclusion is that it would not do much
damage to the rate of return.
Mr. Schweikert. Okay.
Professor Bullard, it is almost the same question. And
then, you actually said something interesting in your testimony
about access to the window. Could you also expand--first the
question, and then expand on that?
Mr. Bullard. It is partly just a flat disagreement with the
view that a buffer can change the fundamental causes of
systemic runs.
And to give you an example, I have read the Squam Lake
proposal. They suggest that 3 percent might be a reasonable
buffer.
If the Lehman Brothers holdings had been 4 percent, Reserve
would have failed, the buffer would have been exceeded, and
then we still would have had a run. And everyone in the
institutional marketplace will know that. There is no
relationship between that and what actually causes that kind of
systemic failure of trust.
A liquidity bank that has access to the discount window has
the potential to create that kind of change in attitude of
institutional investors, who really are the only ones who would
lead a run. I think retail investors would have followed in
September, but they were the only ones who would lead a run,
and they are the ones we should focus on.
But we cannot know that. And not being an economist, I am
not willing to say that I do know the answer to that.
I do know the answer that full faith and credit solves the
problem. But I think a liquidity window certainly has a high
enough probability of changing their attitude that it would
actually prevent precisely the kind of run that a buffer would
fail to prevent.
Mr. Schweikert. And don't harp on not being an economist.
Around here, if you are an economist, we get two or three
answers.
Mr. Bullard. I think it is a badge of honor.
Mr. Schweikert. Mr. Stevens, give me pros and cons on
floating up and down over the net asset value.
Mr. Stevens. I am harder pressed to do the pros than the
cons.
I think many of the people who have suggested floating the
NAV understand implicitly that, as a result of that, we won't
have money funds as we know them any longer. And that would be
just fine with them.
If that is a pro, that is, I think, what they have in their
minds.
The con is that, as has been observed already, the money
will go from institutions into unregulated parts of the
financial system, and we will be replicating the same risks
that are perceived here with respect to money funds. We will
just be doing it elsewhere, where the SEC is not overseeing it
and it is not as transparent.
Much more importantly, though, we will put at risk the
whole mechanism that funds corporations, and State and local
governments, individuals who are accessing the credit markets.
For that matter, even the Treasury's auctions depend very
substantially on money market mutual funds' participation.
So it would be a real shock to the current funding model, a
real shock to those people who depend upon money market mutual
funds for critically important financing. And it would not
solve the systemic risk issue.
Mr. Schweikert. Okay. And we probably barely have time to
touch on this.
Ms. Stam?
Ms. Stam. Yes.
Mr. Schweikert. In today's world, with one of these funds,
what do you think your regulatory cost is, compared to what it
may expand to with some of the discussions?
Ms. Stam. I have to say, interestingly enough, the Vanguard
funds have been operating under very conservative money market
regulations for some time.
And so, the enhancements to Rule 2a-7 that were adopted
recently are very consistent with the way we have managed these
funds historically. So there has been not much of an
incremental cost to those changes.
When we think about the other suggestions that have been
put on the table--buffers of different types, and so on--there
is certainly a cost associated with them. And that is something
that we will have to evaluate as to whether these are workable
solutions.
We would hate to burden the money market fund investors
with a cost that would essentially make the product unusable
for them.
Mr. Schweikert. I am over my time. And you will have to
forgive me, but having been a treasurer of a large county, I
was always--the safety of principal return was always number
one. But that constant concern, that little bit of yield is
what helped employ that next teacher.
Five minutes to Mr. Green?
Mr. Green. Thank you. I will yield to Mr. Lynch, and then I
will proceed next in the rotation.
Mr. Schweikert. Mr. Lynch?
Mr. Lynch. Thank you, Mr. Chairman.
Thank you, Mr. Green.
First of all, I want to agree heartily with the testimony
of Mr. Stevens and Mr. Goebel in terms of the value and
opportunity that mutual funds have created for working-class
families that I represent in my district.
I have companies like Procter & Gamble, Gillette--and I
came out of the ironworker industry myself, the building
trades, and I know there are a lot of hard-working families out
there who, at a very low cost, are now able to invest and, over
their working lives, accumulate significant wealth because of
the structure and stability of mutual funds. There is great
support here for that.
I do want to talk about how most of the controversy here
has been focusing on the Reserve Fund and breaking the buck.
And I just know that there is less and less support in this
body and in the Senate for government guarantees, where the
good faith and credit of the American taxpayer is at risk.
That is what intrigues me about your testimony, Mr. Goebel,
regarding this buffer for the money market mutual funds as a
private sector response to this, where the taxpayer is not at
risk, and that, over time, incrementally, a buffer would be
created.
Could you go over that? I know that is an industry
response. I think it is thoughtful. I think it is responsible.
I think it could work.
I just need to hear a little bit more about it, if you
would.
Mr. Goebel. Sure. Thank you, Congressman.
The fundamental premise that we have is that, to the extent
there is additional residual risk in the product that has not
been resolved--and I should pause and say, that is still an
``if'' for us, the significant liquidity.
One of the issues in Lehman and the crisis that followed
from Lehman was that institutional investors did not know what
was inside our portfolios. They did not have the visibility
into what the actual holdings were.
It is very common now, in the institutional space in
particular, to disclose full holdings within a day or two. So
there is much greater transparency.
If there is an institutional investor out there who has
questions or concerns about what is inside one of our funds,
they can find out very quickly and very easily. The liquidity
changes, the transparency changes have really been significant.
The idea of the buffer is to say that we do not think that
the government should be standing behind these products. We
recognize that there is some risk in them. They are an
investment product. Shareholders are putting their dollars with
us, and our job is to return stability of the principal,
liquidity, and yield, in that order.
So what our approach is, to say that yield, a piece of that
yield over time, shareholders, we think, will accept a
reduction in that yield in order to enhance the stability of
the product.
The question that was asked earlier of the panel was, how
much of the yield, how much of a cost is this going to be? And
the answer to that question is, you tell me how quickly you
want to get to the buffer, and I will tell you how much it is
going to cost. Because if it is 30 basis points, and you take 5
basis points a year, that is a 6-year issue.
One of the questions that we have with all of the issues
with Basel III and banks increasing their capital liquidity is,
how quickly can we get to the right level of protection? And we
submit that this product is very safe and secure today. But the
added idea of taking a little bit of the yield from time to
time out of what shareholders would otherwise receive, fully
disclosed, so shareholders can understand what they are
getting, is a pretty elegant solution.
And the reason for that, the reason why we think it works
in the marketplace, is that a shareholder can make a decision
about the yield that it or he or she is receiving on that
product. And if they do not like the yield, they can go to
another product.
So over the last 20 years, roughly, money market--taxable
money market funds have returned 150 basis points more than
banks. We believe, in a normal rate environment, taking 5, 6, 7
basis points of that yield and diverting it into this buffer
idea is a reasonable trade-off, and shareholders will continue
to invest.
Mr. Lynch. Okay. Thank you.
I do agree that the situation with Lehman, the death knell
there was really the lack of transparency, the uncertainty. No
one knew what kind of product exposure was. And that is a much
different situation than what we have here today.
I know I am short on time, but Mr. Stevens, do you have
anything you want to add to that?
Mr. Stevens. I think it is an idea that is worth very
serious consideration, and I would say it is among a number
that the industry participants and the institute have
developed.
And I would just reiterate the points that I made. As we
consider these things, I think they need to be held up to two
standards. Do they maintain the utility of the product to the
investor, number one? And number two, are they going to still
be consistent with maintaining a robust array of advisers who
want to be in this market and to provide these funds?
I think those are the two criteria appropriate to begin
thinking about what additional reforms should be.
Mr. Lynch. Thank you.
Thank you, Mr. Chairman. I yield back.
Mr. Schweikert. Thank you, Mr. Lynch.
Mr. Dold for 5 minutes.
Mr. Dold. Thank you, Mr. Chairman.
Professor Stulz, a question for you. In your testimony, you
urged regulators to refrain from designating financial firms as
systemically important until they can accurately set forth an
objective and quantifiable criteria to define the term.
Can you give me some examples of some objective and
quantifiable criteria Congress and the regulators can use to
define a systemically important firm?
Mr. Stulz. Financial economists have developed models that
look at the impact of a shock to one firm on the rest of the
financial system. And so, the use of models of that type would
provide an objective benchmark for whether an institution is
systemically important or not.
So you would want to see, based on historical evidence or
based on simulations, what would happen to the financial system
if a particular institution runs into trouble. If such models
were used, it is inconceivable to me that the asset management
industry would show that it has a systemic impact.
Mr. Dold. Can you give me just some sort of an idea of how
many firms out there right now would get the SIFI designation,
that you believe are systemically important financial
institutions? Do you have a number?
Mr. Stulz. I do not have a number, but I believe that the
number would not be in the hundreds; it would not be more than
50. I think we should be very careful in giving that
definition, and we should make absolutely sure that there is
enough objective evidence that the failure of the institution
would have systemic consequences.
Mr. Dold. Okay. Thank you so much. So you are basically at
about 50; I have heard a couple of dozen would be the most.
Mr. Donohue, what is your assessment on that? How many
firms do you think right now would qualify for an SIFI
designation, or should be qualified?
Mr. Donohue. I am not sure I am well informed enough to
make that judgment. I would say, as I have said in my
testimony, that absent extraordinary circumstances, I do not
see asset managers, traditional asset managers or mutual funds
being within that class.
Mr. Dold. Just continuing to follow up with you, sir. In
your opinion, has the SEC oversight of mutual funds worked in
the past? And what can be improved internally within the SEC to
better regulate those funds?
Mr. Donohue. I am a strong supporter of the SEC's role in
regulating mutual funds. I had an interesting seat during the
financial crisis, heading up the Division of Investment
Management.
The expertise that exists inside the SEC, the understanding
of the mutual fund industry and how it operates, and the way
that, in fact, the SEC has operated with regard to mutual funds
over the years, I think is a testament to the right regulation
of an industry. And I think the growth of the industry during
that period is testament to that.
That does not mean that there are not challenges. It is a
70-plus-year-old statute that the Commission has to--they have
a tool in order to adjust the statute, the ability to do
exemptive and other type of relief. But that is time-consuming
and does take resources that the Commission then has to have in
order to adapt.
I think they have done it well. I think, if they do not
have adequate resources in order to do it, then the robust
regulatory regime that funds have had may be compromised.
Mr. Dold. Thank you.
Professor Bullard, if I can ask you, in the absence of the
government bailout under TARP, how many money market funds do
you think would have failed?
Mr. Bullard. I am not sure there is any evidence that
suggests that the TARP bailout had an impact on the
survivability of any particular money market fund. And that was
quite a different kind of exercise in the socialization of risk
that we see banking regulators engaged in.
So I would say, I do not think anyone can know the answer
to that, but my guess is close to zero.
Mr. Dold. Okay. In light of that, do you think it is
necessary that the government be a backstop to money market
funds?
Mr. Bullard. There are a couple of different levels on
which to answer that question.
As an overall systemic regulation question, money market
funds should be regulated considering the context in which all
short-term cash is regulated, which is why I couple my
recommendation of deposit insurance necessarily with weaning
banks from their overreliance.
Within the context of money market funds, I would probably
say, ``no.'' I have a somewhat iconoclastic view of what really
happened in the crisis. Money market funds were safe before;
they were safe after.
I would not have supported any of the improvements the SEC
has made to the safety of the objective portfolios that have
been done to-date. I support the operational changes, the
liquidity changes.
But in terms of whether the product itself has actually
become meaningfully safer, I think that is simply an incorrect
assumption and has essentially been giving into political
pressure.
And what you are going to find in a few years is, the ICI
is going to tell us how many basis points that shareholders in
money market funds have lost because of it, without any real
meaningful change in safety.
On the other hand, systemic risk is a different thing.
There is a good argument that there should be some kind of
systemic risk management put into place. And for that purpose,
as I said, it needs to be something that will force money
market fund shareholders to think differently about money
market funds as a structure.
And the only way you can actually do that is not a buffer,
is not capital requirements, is not increased liquidity, is not
greater safety. There is only one thing out there, and that is
some kind of Federal guarantee.
And the discount window by itself probably would be
sufficient to bring about that change in perception of money
market funds, while costing the government as little as
possible in terms of the costs of socializing risk as a general
matter.
Mr. Dold. Thank you so much.
Mr. Chairman, I yield back.
Chairman Garrett. Thank you.
Mr. Green?
Mr. Green. Thank you, Mr. Chairman.
And to the witnesses, thank you again for appearing.
The financial system depends greatly on confidence, and
confidence depends greatly on transparency.
With reference to the money market system, is there
sufficient transparency? Is there more that we can do to
enhance transparency such that we enhance the confidence in the
system as a whole?
So let me just ask such that I do not go down to every
person, if you think there is more that we can do in the area
of transparency, would you just kindly extend a hand into the
air?
Anyone? All right.
Yes, sir, Mr. Stevens?
Mr. Stevens. I would say, in the dialogue around this
issue, there is a sense that some believe that shareholders do
not understand the risks of money market mutual funds enough.
We are almost victims of our own success here. Our track
record in maintaining that stable NAV per share is really quite
extraordinary. It has gone on for 30 years. Only two money
market mutual funds have ever broken a dollar.
In the case of the Reserve Primary Fund, shareholders lost
a penny on a dollar under circumstances where many other
investors would have thought that was a great day in the market
for them.
To the extent that they do not understand it--even despite
the fact that the prospectuses say these funds are not
guaranteed, they are not insured by the FDIC or by the United
States Government--we can try to make sure, in blaring
headlines, we communicate that to people.
That might be a useful thing to remind everyone, that these
are investment products. They have risks that are quite
minimal. And people need to understand that as they invest in
them.
I would like also just to mention something about the
systemic risk issue. And you have to think about money market
funds in September of 2008 in a context.
The context was essentially a paralysis in the short-term,
fixed-income markets that affected every market participant,
not money market mutual funds uniquely by any means. It was a
crisis in the banking system that paralyzed the markets in
which we invest.
What we needed then, Congressman, was not a Federal
guarantee. In fact, we never asked Secretary Paulson for a
guarantee. We were kind of appalled, because we knew the
consequences when it was extended.
What we wanted was liquidity in the markets in which we
invest, particularly the commercial paper market.
And we may have another crisis one day in that market.
Fixing money market mutual funds is fine, and we think that is
important. But we also ought to attend to the reality that we
are going to need to have liquidity provisions in that market,
as well. And there is no possibility of that at the moment.
Mr. Green. As we review and reflect, obviously, Lehman
comes to mind and the cascading impact that it had on the
entire economic system.
How do you avoid that, given that it generated a run? And
once you get a run, it sometimes is difficult to stop the run.
So how do you do that, and under those economic
circumstances?
I understand the liquidity argument. But how do you
prevent, how do you stop the run or prevent it?
Mr. Stevens. We spent--as a result of the Treasury
Department's White Paper and the President's Working Group
Report suggesting the desirability of exploring a liquidity
facility--the institute and its members spent almost 2 years
putting together a very detailed model of how such a facility
might work, formed as a commercial bank, capitalized by
sponsors of prime money market funds and by shareholders in
prime money market funds, and as a commercial bank regulated by
the Fed and overseen as a bank, but available as a dedicated
market-maker in commercial paper should there be a liquidity
crisis in that market.
It would be able to make a market for money market funds,
prime money market funds, and in the worst circumstances, could
access the discount window.
Mr. Green. I am going to let you continue, but let me
intercede for just a quick second.
Is it anticipated that in the shadows, there will be the
hidden hand of the government?
Mr. Stevens. I was going to say, the only hand of
government here, other than overseeing the institution, would
be that it would, just as every other commercial bank, have
access to the Fed's discount window in the worst kinds of
circumstances. But it would do it with the haircut and at the
expense of the institution and its participants, just as would
be the case with every other commercial bank--so, no different
than others.
Mr. Green. Thank you, Mr. Chairman.
Chairman Garrett. And I thank you.
I will recognize myself.
Along those lines, first of all, as far as the glaring
statements as to evidence that these things are not guaranteed
by the government, of course, that was the case.
I have a little bit in a fund, and any time you call up to
have a transaction and find out what is going on, the recorded
message there is exactly that. Right? It is telling you that
this is not guaranteed by the Federal Government, until after
the fact, you found out that it really was.
Mr. Stevens. And, Mr. Chairman, that is a circumstance that
we would very much like to avoid ever again in the future. As
an industry, we are not seeking a guarantee of any kind from
the government.
Chairman Garrett. Right.
Could you just elaborate a little bit as to what your
protestation was at the time when this was going on, as far as
to the Secretary. Were you saying, ``Stay away, we do not want
this?''
Mr. Stevens. No. We thought the problem was liquidity. And
if the markets in which we invest could be jump-started--as
eventually they were through the Fed's facilities--then that
would solve the problem.
The guarantee was perhaps an appropriate response to an
extraordinary crisis, and it certainly did bolster confidence.
I think most people did not understand how limited the
guarantee was.
What the guarantee was, was if a fund is at risk of
breaking $1, it would have to immediately suspend redemptions
and liquidate its shares. The level of risk to the Treasury was
intentionally very small.
All of our funds participated and paid $1.25 billion in
premiums. There were no claims against the guarantee.
Chairman Garrett. So one of the solutions out there that we
talked about already is a floating NAV.
The question then is, let us say we did that. Would that
preclude--and I will just open this to anyone--would that
absolutely preclude basically what we are talking about here, a
next run on the bank, so to speak?
Mr. Goebel. I would like to take a crack at that.
Chairman Garrett. Sure. Okay.
Mr. Goebel. The floating NAV idea we have talked a little
bit about. We do not think it works for several reasons. One
is, we know shareholders do not want it.
We have surveyed our shareholders. Depending on the
segment, between 70 and 90 percent prefer the stable NAV. The
tax and accounting issue is more complicated.
If you believe that floating the NAV means that the product
will go away, if that is the goal, then floating NAV may not be
a bad policy choice. But if you believe that money market funds
are an important vehicle for investor savings and an important
element of the short-term funding that goes on for
municipalities, then floating NAV is a bad idea.
Chairman Garrett. Let me just stop you right there. Part of
the answer of why you do not want it, or why they do not want
it, is because of that dependency for short-term financing by
corporations.
Is part of the problem then, maybe, that there is just too
much reliance--you said municipalities, but others--on these
funds for short-term financing?
Mr. Goebel. I think--first of all, the business model that
was the poster child for overreliance on short-term funding no
longer exists. There have been significant changes in the
marketplace.
I know we are going to talk a little bit about European
banks later, but as we get into that conversation, the lessons
of overreliance on short-term funding have been learned by
participants in the marketplace, as well. So there are very
different approaches to liquidity, very different understanding
of how much short-term funding ought to be used by a particular
entity.
Money market funds are investors investing in the very
shortest part of the market, trying to get our money back. And
we do, like other very short-term investors, see the problems
that occur in the marketplace and react quickly enough to
protect our shareholders. That is an element of how these
products work.
Chairman Garrett. Okay.
Professor Stulz, there seems to be not much love for the
floating NAV.
Mr. Stulz. I still think that it should be pursued and that
we should study it very carefully.
The great advantage of the floating NAV is full
transparency. The investors know exactly what the value of
their investment is. Currently, they really do not
They can withdraw their money at $1, but that is not the
value of the shares. It is not the fair value of the shares.
The floating NAV has the advantage of the transparency. It
has the advantage of removing the free option that investors
have under the current system that leads to runs.
The floating NAV has some advantages. I agree that it has
operational difficulties, and I think the ICI report describes
them extremely well.
Chairman Garrett. I apologize, but I want to quickly get to
you with regard to SIFIs and your comment that the regulators
should not be declaring some of these financial institutions as
SIFIs until they can accurately define what a systemically
important institution is.
Are you able to help set forth what that criteria should
be?
Mr. Stulz. Financial economists have come up with a number
of models that are helpful in answering that question.
And so, yes, the answer is that I could help.
Chairman Garrett. Okay, that has been one question we have
grappled with here from the day that former Chairman Frank
raised the issue, that we need to go after these systemically
important institutions, to the time that we had Secretary
Geithner here, and Chairman Bernanke.
And we could never quite ever get anyone to actually define
exactly what we were talking about in this situation.
But I appreciate your answer.
The gentleman from North Carolina is recognized.
Mr. Miller of North Carolina. Thank you, Mr. Chairman.
One striking lesson from the financial crisis is that there
were enormous aspects of the financial system that no one knew
anything about. Americans in general did not know anything
about it. And really, no one in Congress knew anything about
it, I don't think, including members of this committee,
including me.
And I do not think it was because we lacked diligence--not
in every case. It was because there was nothing to call our
attention to some of what was going on, some of the changes in
the market, in the financial system.
And those who really did know about it did not see any
percentage at all to calling our attention to it, one of which
was the repurchase market, the repo market. At the time of the
crisis, that was described in the press as a freeze in
interbank lending. But it really was a traditional run.
The only proposal that seems to--and, as I understand it,
the repo market was approximately the same size every night in
daily lending as all deposits. So, it was enormous.
And no one knew the first thing about it, and there was no
regulator even breathing on it. And the run in the repo market
around the time of Lehman--and really before that, Bear
Stearns--is what precipitated most immediately the crisis.
Has anything changed? There has certainly been no
regulatory change. But is there any reason to think that the
repo market is less vulnerable to a run? Is there any more
market discipline in who financial institutions will lend to
through the repo market?
Professor Bullard, you talked about the possibility of runs
in the money market, money market funds. Have you given any
thought to that?
Mr. Bullard. I do not follow the repo market as such. But
the problem with the repo market is that it gives a superficial
sense of confidence, in that it looks like something that is
almost immediate cash, and it is easy to forget that what
stands behind it is a single counterparty, which presents a
significant issue of risk.
The Rule 2a-7, which regulates money market fund holdings,
has long regulated repos in, I think, the right way, by
understanding that you have an issuer standing behind that
repo. And I am not aware of any problems in the money market
fund world that have stemmed from repo liquidity or value as
such.
Mr. Miller of North Carolina. Mr. Goebel?
Mr. Donohue. If I could jump in, actually, when 2a-7 was
amended, actually, the repo positions--position--in 2a-7, which
is the rule that governs money market funds, was strengthened
with regard to what is called the look-through rule on whether
or not you had to look just to the counterparty or whether you
could look through for the underlying collateral. And you can
only look through the underlying collateral if it is government
securities now.
I think it has been strengthened inside money market funds,
not because money market funds had issues, but rather looking
forward to ensure that actually money market funds do not have
issues going forward with regard to having to liquidate their
collateral on repos.
Mr. Miller of North Carolina. But not all the repo market
was through money market funds. Money market funds may have
been participants in the market, but there were mutual funds
who were participants beyond the money markets. Isn't that
correct?
Mr. Goebel. Yes, that is correct.
Mr. Miller of North Carolina. Mr. Goebel?
Mr. Goebel. That is correct.
There is some work going on. The New York Fed has a tri-
party repo commission. There was an understanding that there is
a concentration of risk in certain aspects of the structure,
the way repos are actually effected over the course of the day.
There is a group that has been working on greater
transparency, removing that intra-day risk, understanding how
the confirmation process works, so there is better
understanding in the tri-party repo market. There is also work
to create different liquidity sources in case there are issues
within the repo market.
So there is definitely work under way to strengthen the way
the repo market operates.
If your observation is that there is an investment decision
made every day by money market funds and others to participate
in the repo market, that is certainly true. There is cash that
needs to be invested overnight. There are securities that are
available for this market. And that is something that is
important to the way the markets operate today.
Mr. Miller of North Carolina. Okay, I think, actually, the
concern by the critics of the repo market was that there were
not really decisions being made every day, it really was
reflexive, until it got to the point that Bear Stearns got to,
or till it got to the point that Lehman Brothers got to.
Chairman Bair's concern, and the FDIC's concern, is that,
instead of identifying a firm that was in trouble earlier when
the resolution of that firm would not be quite so expensive or
complicated, the run on the repos usually left--the collateral
required and all the rest--left firms in a crater. They would
hit Earth and leave a large crater, which made it very hard,
much more expensive, and much more complicated, with much more
systemic risk resulting from that.
Mr. Goebel. Can I just say that, when we think about repo,
we ignore the collateral. We receive full collateral for the
investments, but we assume that we have to look to that
counterparty to make that investment good.
So we are very careful to evaluate the counterparty risk of
every repo trade that we enter into.
Mr. Schweikert. [presiding]. Thank you, Mr. Miller.
Chairman Neugebauer?
Mr. Neugebauer. Thank you very much.
I want to associate myself with some of my colleagues who
spoke earlier about the fact that we have almost made an
implied guarantee of money market funds by the fact that the
government stepped in.
And that is something we have to fix, because we cannot let
companies pick up the profits, and the taxpayers pick up the
losses. And so, I think this is healthy discussion.
One of the things that--and I am not necessarily
associating myself with the floating asset value concept at
this particular point in time, but I do--we have to think
about, if you are going to classify yourself as an asset
manager, at that point where the value of the underlying
securities is less than what you are obligated to pay, you are
moving away from an asset manager to you have created a
security that comes with an obligation to the firm managing
those assets.
And so, I guess one of the questions I would have of the
panel is, where am I missing the fact that creating that
additional liability then brings into question, why wouldn't--
if the taxpayers eventually pick that up, wouldn't that have
some systemic implications to it?
Mr. Stevens. Congressman, may I try to provide one part of
the answer?
Mr. Neugebauer. Sure. Absolutely.
Mr. Stevens. We actually have looked very carefully at a
group of money market funds and how the pricing of their
portfolios has been done over time. While the funds transacted
at $1 per share, they also marked their portfolios to market
and carefully examined the extent to which the market value
deviates from that $1 above or below.
We actually issued a paper, which I would be pleased to
submit for the record here, and what we find historically is
that the deviation up or down is extraordinarily minuscule,
even if you bring several places to the right of the decimal.
And the reason for that is because the securities in which
the fund is investing are very short-dated, so they do not have
much interest rate risk. They are extraordinarily high quality,
so they do not have much credit risk.
They are expected to be held to maturity and, therefore,
can be valued at their amortized costs. And that is the
accounting treatment that allows them then to maintain that $1
per share value.
Mr. Neugebauer. Let me stop you there for just a second.
You talk about maturity and credit quality. How about
concentration?
Mr. Stevens. Yes, the concentration is limited under the
rule, as well, so you do not have exposure, overexposure in the
fund to an individual name. There are new rules with respect to
the weighted average maturity of the portfolio as a whole, the
weighted average life of instruments in the portfolio.
The experience of the industry under Rule 2a-7 over time
has been--with the exception of glaring circumstances of the
sort that the Reserve Fund found itself in with the credit
difficulties that Lehman Brothers presented--that the
transacting at $1 really does represent, from a shareholder
perspective, the value of its, or his, or her interest in the
portfolio.
And the degree of success that was had is remarkable. There
has actually been a third of a quadrillion dollars--we don't
think about quadrillions much, even in the Congress--but a
third of a quadrillion dollars that has gone in and out of
money market funds over their history without the loss of any
principal to the shareholder. It shows you the level of success
that these rules and the industry have had over 30 years.
Mr. Neugebauer. Yes, we try not to use that word around
here, because we do not want the Congress to know that there is
something after a trillion.
[laughter]
Mr. Stevens. That is a thousand trillion.
Mr. Neugebauer. Yes, I know.
I think the other question is, and when we go back and
rewind the tape to 2008, what about the amount of underlying
capital that an entity holds versus the amount of issue that
they have and where they have the ability to maintain that
commitment, if you are going to continue?
Does one of the other panelists want to dive into that?
Mr. Goebel. Just to clarify the question, are you asking
about the size of capital that might be required to support any
one of these ideas?
Mr. Neugebauer. Yes.
Mr. Goebel. There are a couple of different theories. One
that you heard was that there needs to be enough money set
aside to avoid any fund ever breaking a buck again. In 2008, it
was 3 cents on Lehman--in the Primary Reserve Fund, excuse me--
and even though, eventually, shareholders received 99 cents.
Our approach is different. Our approach is to say that
there is a cushion, there is an amount of money that is
appropriate to set aside. And it is enough for shareholders to
understand what is happening. It is enough to, over a period of
a 10-day crisis--we have a chart in our attachment that
explains what happens over a 10-day crisis, assuming certain
lock-up in liquidity and diminution in value within the
underlying securities and 60 percent of the fund leaves--you
still have a dollar left for your shareholders.
With a relatively small buffer, what you really do is buy
time. You buy a chance for the markets to resettle. You will
buy a chance for investors to really understand what is
happening.
And, ultimately, if a board, a mutual fund board and the
adviser conclude that they have a product that is no longer
viable, it should be okay, again, for a money market fund to
shutter its doors and say, we are going to return your money to
you, and the rest of the system can continue to operate.
Mr. Bullard. If I could just add one point to that?
Mr. Schweikert. I hope you will forgive me. Any objections
to another 30 seconds?
Please continue.
Mr. Bullard. I just wanted to add that, thanks to a recent
innovation, a really brilliant innovation that we have Mr.
Donohue to thank for is that you can go online now. You can
look historically at the NAV of these money market funds.
I have done that. The first one I looked at was 1.000. The
second one I looked at was 1.0000. I guarantee you, the first
one to start showing up at 0.9999 is going to start losing
assets. And that is, in some ways, the best answer to the point
that Mr. Stevens was making.
This is now very transparent. It is very obvious.
I can tell you, if you took bank balance sheets and you
started forcing them to do that, we would see very different
behavior in the bank sector, as well.
Mr. Neugebauer. So you believe there is market discipline
concepts built into the system?
Mr. Bullard. Yes. Enterprising financial journalists cannot
wait to write the article about the money market fund that is
routinely falling under that 1.0000 number.
Mr. Schweikert. Thank you, Chairman Neugebauer.
Mrs. Maloney?
Mrs. Maloney. Thank you, Mr. Chairman.
And welcome to all the panelists.
I would like to ask Mr. Stevens, you may recall during the
Dodd-Frank markup that I offered an amendment, which was
accepted, to include leverage as part of the criteria for
deciding whether a non-bank should be designated an SIFI, a
systemically important financial institution.
As major financial firms were failing during this crisis,
it seemed that one of the main problems was the degree to which
they were leveraged to really outrageous levels.
Mutual funds and their advisers are not highly leveraged.
And I am wondering if you believe that the regulators are
devoting enough attention to leverage.
Mr. Stevens. Congresswoman, I do recall the efforts that
you made in Dodd-Frank, and we appreciated them. And I think
your insight was exactly correct. Excessive leverage in the
system was one of the fundamental problems that visited upon us
the financial crisis.
One of the reasons that funds came through it so well is
that our portfolios do not reflect any leverage of that kind.
Our maximum leverage ratio is 1.5-to-1. And any borrowing that
a fund does has to be covered by assets so that its
indebtedness would be, if you will, secured.
That has been in our DNA, if you will, since the Investment
Company Act was passed in 1940. And I think it is a fundamental
strength of our institutions.
I hope, frankly, that it will be among many factors that
would persuade the FSOC that SIFI designation is not
appropriate in our case.
Mrs. Maloney. I would also like to ask you and Professor
Bullard, I recently read an article in the Financial Times,
which was written by Professor Robert Pozen, who is an
economist and former mutual fund executive, and who is now a
professor at Harvard University.
And I request unanimous consent to place this article in
the record.
Mrs. Maloney. So granted?
Thank you.
And in this article, Professor Pozen wrote that money
market mutual funds that invest in tax-exempt, short-term
instruments issued by States and municipalities offer investors
an opportunity to invest in tax-exempt securities that banks
cannot offer.
If regulators decide that money market funds cannot
maintain a stable net asset value of a dollar, what would the
impact be on the availability of these types of investments for
consumers?
Mr. Stevens. When we have talked to investors about this
issue, they have told us, in essence, if it is not a dollar in
and a dollar out, you do not get my dollar. That is true
across-the-board.
But this is a particularly compelling case that you cite,
because in the municipal finance area, it is not apparent who
could pick up the shortfall in funding, if you did not have
tax-exempt money market funds available.
There was a question earlier, why do people finance in the
short-term end of the spectrum? And they do it because, in many
instances, it is lower cost. And because they are refinancing
on a regular basis, they can keep a current rate of interest,
in many instances lower than if they are borrowing on a longer
term basis.
For America's communities around the country, access to
that financing is extraordinarily important. And I think Bob
Pozen's piece, which I did read, is exactly right about what is
at risk if we remove that funding from our State and local
governments.
Mrs. Maloney. Thank you.
Professor?
Mr. Bullard. I agree 100 percent with those comments.
I would just add, Mr. Pozen is one of the smartest guys in
the fund industry. I would listen carefully to what he has to
say, and also reiterate that we are talking about people who
are relying for their retirement on income that would be
threatened by removing that product from the marketplace,
especially as we inside the Beltway know so clearly that
exemption, just having been taken away from D.C. residents, I
think, just in the last month.
Mrs. Maloney. Ms. Stam, in your testimony, you noted that
the SEC's recent amendments to money market fund rules have
significantly improved the funds' safety, liquidity, and
resiliency under extreme market conditions.
Do you believe that these recent reforms constitute a
sufficient amount of reform to the money market fund industry?
Or should the SEC pursue additional activities?
And Professor Bullard, if you would respond, as well.
Ms. Stam?
Ms. Stam. Yes, thank you. I believe that the enhancements
to 2a-7 have gone an extremely long way to addressing many of
the concerns that were mentioned here today by a number of the
members commenting.
The amount of increased liquidity, improvements to credit
quality, the transparency that a number of members talked about
being so important to making sure that the marketplace
understands the value of the money market funds' investments--
we think really it has addressed in large measure the concerns
that were faced in 2008.
To the extent that something is left yet to be done--and I
think there are proposals worth considering, and we should
consider them thoughtfully. But the problems that occurred in
2008 were really focused on the movement of large institutional
investors who had a need for intra-day liquidity of their
assets. And the run that precipitated at the Reserve Fund came
from those investors.
To the extent that we look to put further constraints on
this product, we ought to think about tailoring the response to
that market.
Mrs. Maloney. Could we have 30 seconds for Professor
Bullard to respond?
Mr. Schweikert. Without objection, 30 seconds.
Mr. Bullard. As I noted before, I agree as to the
operational and liquidity reforms put in place by the SEC. But
I disagree as to the need for those that go directly to the
specific quality of the assets they held, with respect to which
I do not think there was a good empirical argument that there
were safety issues, with the possible exception of the
treatment of auction rate securities.
Mr. Schweikert. Thank you, Mrs. Maloney.
Chairman Royce?
Mr. Royce. Yes, let me ask a quick question to Mr. Bullard.
You view the assertions as overstated in terms of the
threat of a European debt problem reaching the point where it
impacts money market funds here in the United States, in your
report.
Could you walk us through that in terms of--I might agree
with you, but I just want to hear your thoughts on that. You
think it is overstated and there isn't that amount of debt in
the money market fund system.
Mr. Bullard. What is misleading about the representations
we have been seeing this week is the characterization of those
holdings as simple European bank exposure.
If you look at 2a-7 and the nature of the instruments that
they would be allowed to hold, they would be essentially the
safest, shortest-term obligations issued by those banks, many
of which are a lot safer than some of the banks in the United
States.
I think part of it is driven by a chauvinistic attitude
toward anything that is offshore. Part of it is driven by
banking regulators repeatedly making assertions about the
quality of money market fund assets with respect to European
banks, while at the same time their banks hold long-term
obligations of those same European banks.
What we need, I think, is the SEC to come out and do what
prudential regulators do and do best, which is to say, ``We
have looked at the innards of these funds. We have looked at
what they hold, and this is what we can tell you about them.
They are safe. They are extremely short term. And money market
funds are not vulnerable.''
Mr. Royce. Let me go to a question where I disagree with
you, and that is your proposal for Federal insurance for money
market funds.
It seems to me that moves in exactly the wrong direction,
to do that explicit Federal backstop, to try to regulate these
like a bank when they are not in that category. They do not
have the leverage. They have very different terms of operation.
It just seems to me that, if you put that backstop in, what
it is going to do is encourage a whole lot of additional short-
term financing, which is the opposite of what we want.
And so, when economists talk about this moral hazard
problem, why would we want to go down that path?
Mr. Bullard. I agree I would not go down it alone. What I
would do is go down it on a path that, as I described in an
article I wrote more fully about this issue, down what I call
``the path of least insurance.''
We need to look at the entire market and look at the total
picture of distortions caused by insurance. And while there is
a distorting effect of insuring short-term lending, nothing
compares to the distorting effect and the systemic risk created
by insuring long-term obligations, which is the foundation of
the insurance that we provide for deposits held by banks.
I agree with you. I would not do that by itself. I think
that what we need is to move down a path where we are reducing
the overall socialization of risk in the system, and that any
insuring of money market funds and other short-term assets
should be combined with a long-term attempt to reduce the scope
of government insurance of private sector activity.
And what has happened in the last 3 years is the opposite
of that. We have seen a huge expansion of the socialization of
risk, and I think that we need to look at the big picture. But
I agree completely with your point as to just money market
funds.
Mr. Royce. Yes, I think the problem we have there is, you
are explicitly expanding the safety net in one more area. And
if it is 60 percent of the financial economy now, you are just
ratcheting it up.
But I think, Mr. Donohue, you had something to say?
Mr. Donohue. I wanted to respond to a couple of points. One
is, I think that the debate that is going on about the European
exposure of money market funds is precisely because of the
transparency that money market funds have about their portfolio
holdings, that may not exist inside other areas of the
financial system.
I think it is a healthy debate. One of the things that
gives me a degree of comfort is that many institutional
managers, many institutions that are very highly qualified, get
to see those exposures on a frequent basis, and as my co-
panelist had mentioned, in many cases daily.
They have not moved their money. They are comfortable with
those exposures. They have kept them there.
Mr. Royce. Let me go to Mr. Goebel for a question.
Mr. Goebel, you mentioned that the net asset value buffer
funded by the money market funds as an alternative would
mitigate the potential for runs, without, of course, increasing
taxpayer exposure.
And what I wanted to ask of you, Professor Bullard does not
believe this is enough to prevent a run. What do you think?
Explain that argument, if you will.
Mr. Goebel. I differ with the professor.
What we are trying to do is create an appropriate signal to
shareholders that they do not need to leave.
If you imagine you have 30 basis points of extra benefit,
extra buffer in a fund, the shareholder has a decision. If he
or she believes that there is a risk in the fund that they want
to get out of before that share price drops, they can go. But
by going, they leave behind a bigger buffer for those who stay.
So it is both an incentive not to leave, because you can
see every day that your share is worth more than a dollar. And
if you choose to leave anyway, those who do not are protected.
Now, over time you could imagine a massive credit problem,
a significant crisis in Europe or some region of the world,
that swamps the buffer. And so, we concede that this is not a
solution that solves every issue.
But we think that the buffer, coupled with an understanding
by shareholders that the Federal Government is not a backstop
and not a guarantee, this is a private order solution. And you
need to decide where your dollar is going. Not all money market
funds are equal.
We believe we have a very talented group of people who
spend all day long, resources that are devoted to making sure
the credit is correct, that we are doing the trading
appropriately, that the portfolio management is working. And we
think that people invest with the name of Fidelity, not just
because there is a rule out there that says you get a dollar
back, but because of what we offer.
And we think that is appropriate in the marketplace for
shareholders to be able to make differentiations and really
makes the whole industry work better.
Mr. Royce. And you think there is enough time to ramp up
with that?
Mr. Goebel. In the current--
Chairman Garrett. And that will be your last question,
because we do have votes after this. I want to get all the
questions in before the next vote series.
Mr. Goebel. Certainly. So briefly, we do not think that
the--we need some time to build the buffer, just like we would
need any sort of capital support, just like the banks need to
get to Basel III. We recognize that this is an approach that
will take some time to build up, but we think that is
appropriate.
We do not want to do something that is so precipitous that
the product becomes uneconomical, or shareholders decide they
do not want it.
One has to strike a balance as to what the end state is and
how you get there.
Mr. Royce. Thank you, Mr. Chairman.
Chairman Garrett. The gentleman from Colorado?
Mr. Perlmutter. Thank you.
And I want to thank this panel. This is a very interesting
conversation that we are having. And, several of us having
lived through this, as did you, the 2008 collapse, experienced
a little post-traumatic stress syndrome.
And to be 2, 2\1/2\ years out now, to look back, and try to
be objective, Professor Stulz says, as objective as we can be
in determining what are realistic, reasonable precautions to
take to avoid something like this happening again.
But I guess, when this all occurred, and when it was
starting to occur, terms came up that I had never heard of
before, and I have been a litigator sort of in the financial
arena for a long time.
And so, when you said we need to have objective, defined
terms for what systemic is--and I agree with you, except that
is easier said than done.
And now, it made me think of, do any of you know what the
gastrocnemius is? Anybody suffered a gastrocnemius? It is a
tear of the upper calf. I never knew what the heck it was until
I did it a couple of days ago. But it sure changed my system. I
cannot play in the baseball game. All right?
And I had no clue what auction rate securities were, or
collateralized default swaps. You never know where it is going
to come from. That is all I am saying.
As you try to come up with your objective criteria, be a
little more expansive than narrow. That is all I wanted to say
on that.
This is about confidence, and it is about fear. And when
there is confidence--and Secretary Paulson, did that overnight
guarantee, in effect, to bring confidence to the system, where
there was a run on the system. That was my experience of that
day or those weeks. FDR did a banking holiday.
Now, we are back to normal--as normal, I hope, as we can
get--and continue to develop confidence in the system.
What I really want to understand--because people do look at
this as cash. Out there on the street, it is cash.
Explain to me the difference, really, so I can understand
it, between the buffer and the liquidity bank, if you would,
Mr. Goebel and Mr. Stevens?
Mr. Goebel. Sure. The idea of the buffer is actual dollars
that sit in the fund, that shareholders can see, that is
subject to board oversight, that does not involve the Federal
Government, to ensure that people understand that the incentive
to leave does not need to be there, if there is one, in a
stable NAV product.
Mr. Perlmutter. Is this a fund-by-fund-by-fund buffer?
Mr. Goebel. Yes.
Mr. Perlmutter. Okay.
Mr. Goebel. Every fund would have a buffer.
Mr. Perlmutter. All right.
Mr. Goebel. It would be mandated.
You could imagine different kinds of funds might have a
different level of buffer. There are a lot of details to be
worked out. But in essence, yes, every fund would have its own
buffer.
And so, the real risk that we talk about in money market
funds is this contagion effect, where somebody goes down across
the street. I have to worry about what my money looks like over
here.
If that happens, the idea is that there is no collective
socialization of the risk. Every mutual fund and every complex
has its own buffer.
Mr. Perlmutter. All right. So let me stop you, because Mr.
Schweikert talked about being a treasurer. And I can tell you,
a lot of treasurers in the State of Colorado--because they were
in the primary fund. Okay? And we had to deal with the
bankruptcy and all of that stuff.
Is the liquidity bank different? Is it a general backstop,
Mr. Stevens?
Mr. Stevens. Yes. And you can think about the two proposals
in this way.
One is designed to make sure that there is not the first
fund that breaks the dollar. The liquidity facility is designed
to, if a fund breaks the dollar for credit reasons, to make
sure that it does not have a knock-on effect by making the
markets in which other funds invest illiquid as a result of
massive redemptions.
It is a way of helping funds meet shareholders' demand to
get their cash out of the fund. It socializes not credit risk,
by any means; it socializes liquidity available to the
industry--
Mr. Perlmutter. Okay.
Mr. Stevens. --building it up over time, and essentially
dedicating it as a market marker, particularly in the
commercial paper markets, where there is no one else who serves
that function.
That, it seems to me, was part of the lesson of the crisis,
that we need to make sure that those markets function well,
because they are so essential for American businesses.
The liquidity facility would allow, if you will, money
market funds to have an opportunity to exchange money, good
commercial paper, for U.S. Treasury obligations or cash that
they then could, in turn, meet redemptions with, and it would
be put together as a commercial bank under the normal
supervisory arrangements with the banking regulators.
Chairman Garrett. Will the gentleman yield back?
Mr. Perlmutter. I was just going to thank the panel, if I
could.
Chairman Garrett. You got it.
Mr. Perlmutter. Because this is a very good conversation.
And I think we have to continue it, because now we can look
back properly on what happened without just some knee-jerk
reaction, and really do this, I think, in a good way. And I
appreciate the testimony.
Chairman Garrett. Thank you.
Mr. Perlmutter. Now, I yield back.
Chairman Garrett. There you go.
Mr. Fitzpatrick?
Mr. Fitzpatrick. Thank you, Mr. Chairman.
I also want to thank the panel for your testimony this
morning.
Professor Bullard, in a recent op-ed opinion piece, you
wrote that the Department of Labor's fiduciary duty proposal,
as it related to 401(k)s and pension plans, missed the mark. I
think those were your words.
Can you elaborate on how Labor's rule is flawed and discuss
for us how you would proceed, or what action we should take?
Mr. Bullard. The proposal, I think, is right on the mark in
the sense that the use of the term ``fiduciary'' has been
unnaturally limited by the Department for decades.
Beyond that, however, the way that the Department
approached the problem was to put the cart before the horse and
expand the fiduciary definition that very many people in the
industry would not be able to conform to in a reasonable period
of time.
And this is because the Investment Company Act, actually,
ERISA, which is the statute they are interpreting, has a kind
of shadow set of statutes. There are exemptions. And those
exemptions are actually the way that money managers who have
ERISA clients operate. They live under those exemptions, for
the most part, not under the actual statute.
And DOL went ahead and redefined the term ``fiduciary''
without laying out how it was going to modify those exemptions
to accommodate the expanded category that it created.
Now, it may be, and I might agree with them, that some of
them should not be expanded. But that is a debate that has to
be had, and is functionally a debate that has to be had, before
you expand the category. That is what you might call a pro-
industry view of what is wrong with it.
The shareholder point of view is that, at the same time it
put the cart before the horse, it created an exception to the
prohibited transaction exemptions--prohibitions--that
completely swallowed the rule.
It created what is known as a seller exemption that allows
you essentially to say that, because I am a seller, I do not
owe you a fiduciary duty.
And DOL already has a prohibited transaction exemption, I
think it is PT-71, that covers exactly the kind of transaction.
And the proposal it created swallows the exemption, greatly
expanding that category, without any real thought as to whether
it is appropriate, especially as to retail investors.
And to give you an example, it would mean that a mom-and-
pop who goes and buys a municipal security from their broker
would not be protected from ERISA, to the extent it should
apply.
That is really just the beginning of the problems that a
short op-ed can deal with. There are problems in the drafting
of the rule. There is a fundamental problem of the Department's
consideration of extending it to individual retirement
accounts, which are, fundamentally, not really ERISA vehicles.
And then finally, a significant problem that is really what
caught my interest is that the DOL proposal is now interfering
with what I think should be a primary agenda item for this
committee, and that is the issue of the fiduciary duty as
applied to broker-dealers when providing retail, personalized
investment advice.
Mr. Fitzpatrick. How would you suggest that we deal with
the flawed rule then? Any recommendations?
Mr. Bullard. I think that the committee should go ahead and
narrowly focus on the SEC's role and use as much persuasive
power as possible to get DOL not just to delay, but essentially
put its process on hold until we see how that unfolds.
The SEC's fiduciary will overlap precisely with a large
percentage of those Commission-based brokers who will become--
who may become--fiduciaries under the SEC rule and become
fiduciaries under ERISA.
And that double whammy is not an appropriate way to go
about extending regulation, especially when the way the law is
structured, it is much more appropriate for the SEC to go first
to see how that system works before you attack the industry
with ERISA, which has far many more restrictions, and is far
more difficult to comply with, than the Federal securities
laws.
Mr. Fitzpatrick. Do any of the other panelists wish to
comment on that?
Ms. Stam. I would say that, we have paid a lot of attention
to this rule. And I think that one of the concerns of the
fiduciary standard as proposed is that it has the unintended
effect of interfering with key services that may be provided to
plan participants or holders of IRAs.
And I think it is something that, actually, DOL could
address quite simply with some thoughtful re-proposal of the
provision. We are hoping that they could address that. It would
be a pity to cut off some of the types of services just because
there are sort of technical problems with the definition of
``fiduciary.''
Mr. Fitzpatrick. Ms. Stam, my district is Bucks County and
Montgomery County, so I have quite a few constituents who are
employees of Vanguard.
As a significant sponsor of mutual funds, aside from this
fiduciary duty issue, what do you think the Congress should be
focusing on?
Ms. Stam. One of the things that we said in our written
testimony is that mutual funds have really fared quite well.
And when we think about what is important to us going forward,
we really think about the strength and the efficiency and the
transparency of the market.
It is why--we are in the financial markets every day on
behalf of our clients. We expect those markets to be strong and
transparent. And we would spend our time looking to make sure
that those conditions continue to exist.
It is why we care deeply about the derivatives markets and
strong regulation of those markets. It is why we care about
transparency in municipal markets. It is, frankly, why we care
that the regulatory activities of the various regulatory
agencies are consistent and not duplicative, so that we can
deliver efficient and effective returns to our clients.
Mr. Fitzpatrick. Thank you for your testimony. I appreciate
it.
Chairman Garrett. The gentleman yields back.
Mr. Peters?
Mr. Peters. Thank you, Mr. Chairman.
And thank you, panel, for being here with some very
interesting discussions.
First off, I want to thank the mutual fund industry for
what you do. The products that you provide for middle-income
Americans allow them to save efficiently and invest in
important lifetime objectives that we all have, like retirement
and saving for our children's education. And that would not be
possible without the variety of products that the mutual fund
industry offers. So I appreciate what you do in that regard.
I want to change gears a little bit in some of the
questions that have been asked to a different subject, but I
know you are all very involved in this area.
Along with one of my colleagues, John Campbell, from the
other side of the aisle, we have introduced legislation to
reform the housing finance market, the GSEs, and unwind Freddie
Mac and Fannie Mae. There are a number of proposals that have
been floating around here in Washington right now to deal with
that.
But as an industry, you invest hundreds of billions of
dollars in GSEs with your products. I just want to get a sense
of some of your principal concerns that you have as an
industry, as Congress is looking at reforming the GSEs. And so,
I would open that up.
It is a wide discussion, but I am just kind of curious as
to some of your principal concerns that we need to be focused
on as we reform the GSEs.
Mr. Stevens. Congressman, maybe I can begin the answer. I
think one important realization is that there are a lot of
legacy securities out there that are held very widely in the
marketplace.
And while we very much support the Congress' direction of
unwinding or significantly limiting the GSEs and moving the
Federal guarantee, or limiting it in some fashion, I think it
is very important that we not do anything that disturbs the
guarantees that exist with the outstanding legacy securities.
That is something that we have been seriously concerned about.
I know that there has been interest in the committee in the
development of a covered bond market, and the dealer firms have
expressed some very serious interest in that. That is a
conversation we are currently having with our membership, and
look forward to acquainting the subcommittee with our findings.
But I do applaud you and your colleagues here for looking
at alternatives that would remove what perhaps is the largest
of the moral risks that we experienced as a result of the
recent crisis.
Mr. Goebel. I guess I would add that, by merely asking the
question, you have gone a long way toward answering our
concern, which is that we think that this is obviously a very
important market to us. And we are sensitive to whatever the
changes are that come about, that they are transparent and
signaled in advance, so we can make appropriate portfolio
management decisions.
We also--I would echo Mr. Stevens' comments that there are
a great deal of legacy assets out there, and particular
evaluations were made of those securities based on the terms as
they exist today and at the time.
So we are very interested in making sure that there are
limited disruptions to that and an understanding going forward
of exactly what the changes will look like and how that will
happen, so we can make sure that we minimize any impact on our
shareholders.
Mr. Peters. Anybody else?
As far as concerns about the legacy and the guarantees that
are in that, there is a question going forward as to whether or
not there still is a government role when it comes to
securities.
The proposed bipartisan legislation that I have with Mr.
Campbell still has a government role, although there is
considerable private capital ahead of any sort of government
guarantees. But the idea is that some sort of government
guarantee is necessary to attract investors into those
securities, particularly if they are long-term securities.
Do you share that view as an industry, generally?
Mr. Goebel. The types of investors and the decisions about
what portfolios those securities are appropriate for certainly
depends on the existence of the guarantee. So whether there is
another market, or different types of investors, or different
types of rates that might be required in order to incent the
purchasers, I guess the answer is, it sort of depends on what
that looks like.
Mr. Peters. Right. Okay.
The other point that I think bears repeating, and I have
heard it over and over again today, is the concern about the
net asset values and if you are off that dollar.
I spent 20-some years in my private sector career in the
investment business dealing with private clients, and I can
assure you that they all wanted the $1 NAV. And I know that
your studies show that 70 percent of people will not invest. I
think it was probably close to 100 percent of my clients who
would have said that is the product they want, to make sure
that they have that $1 value.
So I think it is very important that we preserve that and I
will continue to work with you to preserve that, because it is
a necessary part of not only financing, as you mentioned, the
government short-term securities to our municipalities, but
also to our other companies and manufacturers.
I am in a manufacturing State. I am from Michigan. We have
Chrysler and the auto companies that go in for short-term
financing, and commercial paper in particular.
Maybe, if someone could just elaborate for us, too. If
money is pulled out of the money market funds--you have already
talked, Mr. Stevens, about the impact on our municipalities and
how difficult it will be to fund--what about corporations?
Where will they go for that short-term money? And if there are
not adequate places, what sort of consequences does that have?
This NAV is more than just investors not wanting to invest;
the NAV breaking that dollar will have an impact on the economy
and on jobs, I presume. Is that accurate?
Mr. Stevens. There is no question in my mind about that,
Congressman.
The commercial paper market represents funding for
payrolls, represents funding for inventories, represents
funding that is essential to maintain employment.
And if that market constricts greatly, and the
corporation's cost of financing goes up, their ability to tap
the short-term markets is compromised, it is going to have a
real impact on their operations. It is an example of how
embedded money market funds have become in the broad economy.
And what we have said over and over again in meeting after
meeting is, fine, let us address whatever reforms are needed
here, but let us not throw the baby out with the bathwater.
Mr. Peters. Thank you.
Mr. Donohue. I would, if I could, just interject two
things. One is that I think many of the institutional investors
that are in money market funds may themselves do one of two
things, which is, either they will pull the money out of the
money market funds, if that is their selection, and they may
directly go into the commercial paper market, which is what
they had done 15, 20 years ago.
Alternatively--and this is something that I think would not
be a very good result for anyone--is that they can go into
unregulated pools, where there is no transparency, where there
is no 2a-7, there is no regulatory regime around that, and
obtain many of the same benefits that they believe they are
getting from money market funds, but actually not. But I think
that is the worst answer.
Chairman Garrett. All right. Thank you. I thank you for the
follow-up question.
Mrs. Biggert?
Mrs. Biggert. Thank you, Mr. Chairman. I will be brief.
I think Mr. Fitzpatrick asked the question that I have the
most concern with, because many of your companies'
representatives have come in to me and have raised the concerns
about the Department of Labor's proposed rule changing about
fiduciary when advising, particularly, retirement plans.
I have asked the question to both the SEC and to the
Department of Labor, at various hearings that we have already
had, whether they were working together, so that there would
not be a difference as far as what each of these agencies would
come up with.
And both of them said that they were working together. But
it does not appear that really is the case.
I think that the SEC has already came out with a study, and
it kind of, I think, gives us an idea of what their rule will
be. And the Department of Labor has now come out with a rule, a
proposed rule, although we have not really seen it. And I do
not think that they are the same.
So I wondered, how are we going to solve that problem, if
there are different rules?
And I think we could have headed it off, but I would assume
that the Department of Labor wants to get the rule right. And
what can we do, then, to further bring those two back together?
Maybe, Mr. Bullard, you seem to be the most knowledgeable.
Mr. Bullard. I certainly would not say I am necessarily the
most knowledgeable.
But I was actually in the office under Mr. Donohue's
predecessor who was responsible for that communication with
DOL. And I assure you, the communication is going on, but there
is undoubtedly disagreement between the two.
And there is also a limitation to the extent they can work
together, because the effects of being a fiduciary under ERISA
are so different and so much more onerous than under the
Federal securities laws.
Another reason is that, to a great extent, broker-dealers'
conduct is in many contexts already subject to a fiduciary
duty. The SEC's proposal really goes primarily to the public
enforcement mechanism; whereas, DOL's proposal is very much a
private liability issue, and predominantly a private liability
issue.
Those are just two examples of the way in which those
simply are not processes that necessarily can be coordinated.
But that does not mean that you should not see the outcome of
the SEC's sort of more fundamental, ground-level approach
before you go ahead and subject ERISA to many of exactly the
same people whose activities under the SEC standard may solve a
lot of DOL's concerns.
Mrs. Biggert. And I would agree. It seems to me, though,
who is going to get it out first? And I think that will cause
problems. But I appreciate what you are saying.
And I yield back.
Chairman Garrett. The gentlelady yields back.
The gentlelady from New York?
Dr. Hayworth. Thank you, Mr. Chairman.
Of course, we have talked a bit about SIFI designation. And
for banks, of course, SIFI carries with it potential advantages
in terms of how creditors might view that guarantee. And, of
course, there are costs, as well, to SIFI designation. And
indeed, I am skeptical of that designation in its entirety.
But in terms of the proposal that perhaps SIFI designation
should also be applied to mutual funds, could any of our
panelists elaborate on--and perhaps we can start with Mr.
Stevens--the implications more specifically of SIFI designation
on our mutual funds?
Mr. Stevens. If a fund, or a fund complex, or a fund
adviser were designated as a systemically important financial
institution, under Dodd-Frank there would be two consequences:
one, they would be targeted for heightened prudential
supervision by the Federal Reserve; and two, they would be
subject to capital and other kinds of requirements.
Prudential supervision is an alien concept in our world.
While Professor Bullard has talked about the SEC perhaps
becoming a bit more prudential, the fact of the matter is, its
regulatory model has never been of a nature that is omnipresent
in our businesses and telling us how to operate them in the way
that the Federal Reserve and other banking regulators do with
respect to depository institutions.
The implications of that are unknown, perhaps unknowable.
And I have heard Federal Reserve officials say that they are
kind of puzzled by it, too, if they had to move in that
direction.
The capital issue is even more murky, because, to a very
large degree, advisers, while they need capital to assure that
they have sufficient robustness to fund ongoing operations, do
not have capital requirements of the sort that banking
institutions do. And mutual funds, you can either look at as
having zero capital or 100 percent capital.
So it is a question, I think, that I am not exactly sure
what the answer is. And I would tell you, Congresswoman, I hope
we do not have to find out.
Dr. Hayworth. Agreed.
Any of our other panelists?
Ms. Stam. Yes, I could add to that. I think that,
interestingly enough, the reasons why there was a determination
that there should be the designation of systemically important
financial institutions are the type of issues that occurred in
2008.
But if you think about mutual fund structure and
regulation, it is sort of the antidote to all of those
concerns, so you do not have the leverage, you do not have the
lack of transparency and a lot of the questions that were
raised that cause the attention to the sort of unregulated or
uncovered segment of the industry.
Clearly, I think we all agree on this panel that mutual
funds or their advisers were not intended. But it is really
important to understand that the mutual funds themselves are
separate entities, and there is no bleeding over between the
funds and the adviser. And so, difficulties with an adviser
would not impact a mutual fund.
And the other thing, I think it is really important to note
that size is indicated as a factor to be considered. But in the
mutual context or in a mutual fund complex, the fact that you
have assets under management are really irrelevant, because of
the mutual fund structure that oversees those assets, and they
are individually owned by millions of individual investors, and
the adviser has no ownership rights to those assets.
So we are hoping that reason will prevail when the
designations are made.
Mr. Goebel. I just want to expand. I think that Ms. Stam
got exactly the right point, which is, as I mentioned, we have
over 400 mutual funds. We think that the designation would be
required on a fund-by-fund basis. Each entity is a different
entity. Some of them are organized as trusts, so it would not
be 400 designations. But it would be more than a dozen, more
than a couple of dozen.
You could designate it an adviser. But are you designating
the adviser, and then turning around and worrying about the
capital in the funds in another place?
What is a capital standard that applies to an adviser that
has a particular balance sheet that looks very different,
because it does not own the assets of the fund?
That relatively basic structural point of mutual funds
makes it very hard for any of us to answer questions about how
these rules apply, because they just were not designed for the
way we operate.
Mr. Bullard. Yes, if I could just add to that. I think that
the SIFI question really has two parts: first, whether there is
an inherent systemic issue raised by a structure; and second,
if there is, do we already have a comprehensive regulatory
regime in place dealing with that?
As to both one and two, the answer for non-money market
funds is clearly that they should not be SIFIs. If you ask--any
question you ask that someone thinks represents systemic risk,
the answer for non-money market funds is ``no.''
But I strongly disagree with Mr. Stevens that the SEC is
not a prudential regulator as to money market funds. If Rule
2a-7 is not prudential regulation, I do not know what it is.
The answer for money market funds, to the first question,
is clearly that it is systemically important in some respects.
I think that the second question, though, is the one we
really need to deal with, whether the current regime and the
current regulator is the right one to do it. If Mr. Stevens'
point about the SEC not being a prudential regulator goes that
deeply into its structure that it cannot do the job for money
market funds, then we need to re-think whether it is a good
idea to have what is essentially a free market regulator also
being a prudential regulator.
But we cannot lose sight of the fact that money market
funds are prudential regulation, and their regulator needs to
act like one.
Mr. Stevens. I think this is a definitional squabble more
than anything else.
But from where I sit, it makes no sense to designate 642
money market mutual funds as systemically important financial
institutions and saddle them with Federal Reserve oversight and
capital requirements. If there is a deficiency here, if there
are reforms that are needed, they should not be arrived at
through the designation process. That is my key point.
Dr. Hayworth. Thank you all. It sounds as though that kind
of designation would take an awful lot of energy out of our
money market funds, etc., when we desperately need more energy
in the marketplace.
And I yield back my time. Thank you, Mr. Chairman.
Chairman Garrett. The gentlelady yields back her time.
I want to extend another 30 seconds to the gentleman from
Colorado. He indicated that he had the most salient and
poignant question of the day.
[laughter]
Thank you.
Does the gentlelady have anything? Okay.
Before I dismiss the panel, we have, without objection,
several letters with regard to the hearing to be entered into
the record: from the New Jersey State Chamber; from the New
Jersey Business and Industry Association; from the New Jersey
State League of Municipalities; from the Chamber of Commerce of
the United States of America; from the Greater Boston Chamber
of Business; from the Association of Financial Professionals;
from the Dallas Regional Chamber; from the Association of
Commerce and Industry; from the Fort Worth Chamber; from the
National Association of Corporate Treasurers; from Davenport
and Company; and from the American Public Power Association.
And I guess from all the rest, and among others: the
Council of Development Finance Agencies; the Council of
Infrastructure Financing Authorities; the Government Finance
Officers Association; the International City Council Management
Association; the International Municipal Lawyers Association;
the National Association of Counties; the National Association
of Local Housing Finance Agencies; the National Association of
State Auditors; the National Association of State Treasurers;
the National League of Cities; and the U.S. Conference of
Mayors.
And without objection, those letters with regard to today's
hearing will all become a part of the record.
And speaking of the record, the record will remain open for
30 days for additional questions for members who are here, or
other salient and pointed questions from the gentleman from
Colorado, which he should make, as well. And your responses
will also be made a part of the record.
On that point, I think there was only one question which I
did not use additional time for, which was Professor Stulz. And
you said you had some comments that you wish to make. If you
would so kindly, I would appreciate getting a note back with
you. That was on the point before we were raising about as far
as defining our criteria for systemically important
institutions like that.
If you would like to submit that in writing, that would be
most beneficial.
And to the rest of the panel, we very much appreciate it.
It was an interesting and informative panel. And where do we go
from here? We will just begin to digest everything that you
have said.
Thank you so very much. I appreciate it.
And the hearing is adjourned.
[Whereupon, at 11:50 a.m., the hearing was adjourned.]
A P P E N D I X
June 24, 2011
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