Originally published in the Wall Street Journal on Oct. 6, 2016
Everyone knows that government regulators will never be able to accurately predict future financial risks. But could they stop creating them?
Last week we told you how the government encouraged a run on Deutsche Bank by demanding $14 billion—most of the value of the firm—to settle a mortgage case. In August we explained how a mistake in new money-fund rules had investors fleeing and promised to make the next financial crisis more challenging. As the Securities and Exchange Commission prepares to begin enforcing the new rules next week, global regulators are now threatening to repeat the mistake across the asset management industry.
The SEC’s mistake was to encourage money-market mutual funds to impose new fees and redemption limits in times of stress. These limits are often called “gates” because they would temporarily lock investors into a fund even when they wish to sell. This is a recipe for inflaming a market panic. Uncertain investors wondering if the fees and gates are about to come crashing down on them will start guessing about the right time to rush for the exits.
Many of them already have. The realization among corporate treasurers that their money might not be available in a crisis is a big reason institutional prime money market funds now hold merely $199 billion, down from more than $800 billion in late March. Assets in retail prime funds have fallen by more than $100 billion in the last four months.
Yet global regulators watching this investor stampede seem to think it should be a model for other markets.
The Financial Stability Board based in Basel, Switzerland is a club of financial regulators from the world’s largest economies plus international outfits like the World Bank. Dominated by central bankers, the board spends much of its time advocating that bank regulators should enjoy jurisdiction over companies outside of banking.
Uncomfortable with the freedom that allows investors in the capital markets to easily enter and exit investment positions, the stability board recently proposed that national regulators make it more difficult and expensive for investors to sell in a crisis. Even while acknowledging potential “spillover effects,” the Basel crew urges their fellow financial bureaucrats to consider employing “liquidity risk management tools” such as fees and gates to block investor exits.
The Committee on Capital Markets Regulation, led by Harvard’s Hal Scott, recently wrote to the Basel boys to warn them that “the threat of such restrictions being implemented during a crisis could cause investors to accelerate their withdrawals in an attempt to redeem their shares before fees or gates are activated. This escalation of withdrawals could then amplify instability and fuel contagion throughout the financial system.”
The stability board is now done accepting such comments and intends to finalize its plan by the end of the year. It’s hard to remember an idea that has failed as quickly and as completely as the SEC’s effort to bar the door on fleeing money-fund investors. Naturally the policy is well on its way to being a model for bureaucrats world-wide.