* SEC action is 'first-best' option; FSOC is 'second-best'
* Fed official still hopes SEC will adopt money market rules
* Tarullo also floats 'upper bound' on bank size
By Jonathan Spicer
PHILADELPHIA, Oct 10 It would be best if the
Securities and Exchange Commission finally moved forward with
money market reforms instead of leaving the job to the new U.S.
financial risk council, a top Federal Reserve official said on
W edn esday.
Fed Governor Daniel Tarullo said it was unfortunate that the
SEC, the primary regulator of the $2.6 trillion industry, has so
far failed to advance new rules for the market, which since the
financial crisis has been viewed as posing a systemic risk.
In a wide-ranging lecture that touched on the limits and
difficulties of crafting new rules in the wake of the 2007-2009
financial crisis, Tarullo, the U.S. central bank's point person
on regulation, also floated the idea that the size of banks
should be capped.
The Fed official's comments on money market funds, however,
shed some light on how regulators intend to deal with the
industry after SEC Chairman Mary Schapiro said on Aug. 22 that
her agency would not formally put forward its reform proposals,
since three of five commissioners opposed them.
That left the next move to the Financial Stability Oversight
Council, or FSOC.
"Each of the options open to the FSOC and the rest of its
constituent agencies is decidedly a second-best alternative as
compared to a change in SEC rules to remove the fixed net asset
value exception, to require a capital buffer that would staunch
or buffer runs, or measures of similar effect," Tarullo said at
the University of Pennsylvania Law School.
Any FSOC reforms would be worse for the funds themselves, he
argued, because the tools available to the council "do not fit
the problem precisely and thus will not regulate at the least
cost to the funds while still mitigating financial risk."
The industry says money market funds are a safe investment
with attractive returns, while critics worry that they are
vulnerable to runs and create a false sense of security for
investors who do not realize they are not backed by federal
Schapiro has argued that a series of reforms the SEC adopted
in 2010 do not go far enough to prevent runs on funds like the
one experienced in 2008 when the Reserve Primary Fund "broke the
buck," meaning its net asset value fell below $1 a share.
On Sept. 27, U.S. Treasury Secretary Timothy Geithner called
on the FSOC to formally ask the SEC to move forward with new
rules. He also said the council should consider exercising other
powers to regulate the money market fund industry more tightly.
The next day, Daniel Gallagher, a Republican SEC
commissioner who had previously helped block the fund reforms,
told Reuters he hopes the agency will consider a fresh package
In a nod to those comments, Tarullo said: "My hope, of
course, is that recent indications that other SEC commissioners
are now willing to move forward with reforms will lead to the
SEC adopting first-best measures in the near term."
While Tarullo sits in on FSOC meetings, Fed Chairman Ben
Bernanke is the central bank's official representative on the
The FSOC's options include imposing restrictions on banks'
and other firms' "ability to sponsor, borrow from, invest in, or
provide credit to" money market funds that do not have
structural protections, Tarullo said.
The council could also designate money funds as
"systemically important" and thus subject to capital and
liquidity rules included in the Dodd-Frank financial reform law,
For non-banks in general, the FSOC is "actively considering"
possible systemically important designees, Tarullo added.
Turning to bank acquisitions - which under Dodd-Frank are
reviewed by the Fed for threats to financial stability - Tarullo
said the fact that lawmakers did not set an "upper bound point"
makes things difficult for regulators.
"To the extent that a growing systemic footprint increases
perceptions of at least some residual too-big-to-fail quality in
such a firm, notwithstanding the panoply of measures in
Dodd-Frank and our regulations, there may be funding advantages
for the firm, which reinforces the impulse to grow," he said.
"There is, then, a case to be made for specifying an upper
bound," Tarullo said, adding, "It would be most appropriate for
Congress to legislate on the subject."