[House Hearing, 113 Congress]
[From the U.S. Government Publishing Office]
EXAMINING THE SEC'S MONEY
MARKET FUND RULE PROPOSAL
=======================================================================
HEARING
BEFORE THE
SUBCOMMITTEE ON CAPITAL MARKETS AND
GOVERNMENT SPONSORED ENTERPRISES
OF THE
COMMITTEE ON FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED THIRTEENTH CONGRESS
FIRST SESSION
__________
SEPTEMBER 18, 2013
Printed for the use of the Committee on Financial Services
Serial No. 113-44
[GRAPHIC NOT AVAILABLE IN TIFF FORMAT]
U.S. GOVERNMENT PRINTING OFFICE
86-879 PDF WASHINGTON : 2014
___________________________________________________________________________
For sale by the Superintendent of Documents, U.S. Government Printing Office,
http://bookstore.gpo.gov. For more information, contact the GPO Customer Contact Center, U.S. Government Printing Office. Phone 202-512-1800, or
866-512-1800 (toll-free). E-mail, [email protected].
HOUSE COMMITTEE ON FINANCIAL SERVICES
JEB HENSARLING, Texas, Chairman
GARY G. MILLER, California, Vice MAXINE WATERS, California, Ranking
Chairman Member
SPENCER BACHUS, Alabama, Chairman CAROLYN B. MALONEY, New York
Emeritus NYDIA M. VELAZQUEZ, New York
PETER T. KING, New York MELVIN L. WATT, North Carolina
EDWARD R. ROYCE, California BRAD SHERMAN, California
FRANK D. LUCAS, Oklahoma 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 STEPHEN F. LYNCH, Massachusetts
MICHELE BACHMANN, Minnesota DAVID SCOTT, Georgia
KEVIN McCARTHY, California AL GREEN, Texas
STEVAN PEARCE, New Mexico EMANUEL CLEAVER, Missouri
BILL POSEY, Florida GWEN MOORE, Wisconsin
MICHAEL G. FITZPATRICK, KEITH ELLISON, Minnesota
Pennsylvania ED PERLMUTTER, Colorado
LYNN A. WESTMORELAND, Georgia JAMES A. HIMES, Connecticut
BLAINE LUETKEMEYER, Missouri GARY C. PETERS, Michigan
BILL HUIZENGA, Michigan JOHN C. CARNEY, Jr., Delaware
SEAN P. DUFFY, Wisconsin TERRI A. SEWELL, Alabama
ROBERT HURT, Virginia BILL FOSTER, Illinois
MICHAEL G. GRIMM, New York DANIEL T. KILDEE, Michigan
STEVE STIVERS, Ohio PATRICK MURPHY, Florida
STEPHEN LEE FINCHER, Tennessee JOHN K. DELANEY, Maryland
MARLIN A. STUTZMAN, Indiana KYRSTEN SINEMA, Arizona
MICK MULVANEY, South Carolina JOYCE BEATTY, Ohio
RANDY HULTGREN, Illinois DENNY HECK, Washington
DENNIS A. ROSS, Florida
ROBERT PITTENGER, North Carolina
ANN WAGNER, Missouri
ANDY BARR, Kentucky
TOM COTTON, Arkansas
KEITH J. ROTHFUS, Pennsylvania
Shannon McGahn, Staff Director
James H. Clinger, Chief Counsel
Subcommittee on Capital Markets and Government Sponsored Enterprises
SCOTT GARRETT, New Jersey, Chairman
ROBERT HURT, Virginia, Vice CAROLYN B. MALONEY, New York,
Chairman Ranking Member
SPENCER BACHUS, Alabama BRAD SHERMAN, California
PETER T. KING, New York RUBEN HINOJOSA, Texas
EDWARD R. ROYCE, California STEPHEN F. LYNCH, Massachusetts
FRANK D. LUCAS, Oklahoma GWEN MOORE, Wisconsin
RANDY NEUGEBAUER, Texas ED PERLMUTTER, Colorado
MICHELE BACHMANN, Minnesota DAVID SCOTT, Georgia
KEVIN McCARTHY, California JAMES A. HIMES, Connecticut
LYNN A. WESTMORELAND, Georgia GARY C. PETERS, Michigan
BILL HUIZENGA, Michigan KEITH ELLISON, Minnesota
MICHAEL G. GRIMM, New York MELVIN L. WATT, North Carolina
STEVE STIVERS, Ohio BILL FOSTER, Illinois
STEPHEN LEE FINCHER, Tennessee JOHN C. CARNEY, Jr., Delaware
MICK MULVANEY, South Carolina TERRI A. SEWELL, Alabama
RANDY HULTGREN, Illinois DANIEL T. KILDEE, Michigan
DENNIS A. ROSS, Florida
ANN WAGNER, Missouri
C O N T E N T S
----------
Page
Hearing held on:
September 18, 2013........................................... 1
Appendix:
September 18, 2013........................................... 49
WITNESSES
Wednesday, September 18, 2013
Bair, Hon. Sheila C., Chair, Systemic Risk Council, and former
Chair, FDIC.................................................... 10
Chandoha, Marie, President and Chief Executive Officer, Charles
Schwab Investment Management, Inc.............................. 12
Gilligan, James P., Assistant Treasurer, Great Plains Energy,
Inc., on behalf of the U.S. Chamber of Commerce................ 14
McCoy, Hon. Steven N., Treasurer, State of Georgia, on behalf of
the National Association of State Treasurers (NAST)............ 8
Stevens, Paul Schott, President and Chief Executive Officer, the
Investment Company Institute (ICI)............................. 15
APPENDIX
Prepared statements:
Moore, Hon. Gwen............................................. 50
Bair, Hon. Sheila C.......................................... 52
Chandoha, Marie.............................................. 59
Gilligan, James P............................................ 72
McCoy, Hon. Steven N......................................... 84
Stevens, Paul Schott......................................... 111
Additional Material Submitted for the Record
Garrett, Hon. Scott:
Letter to the SEC from 12 Federal Reserve Bank Presidents,
dated September 12, 2013................................... 123
Letter from the Mutual Fund Directors Forum, dated September
17, 2013................................................... 132
Written statement of the Financial Services Roundtable....... 133
Lynch, Hon. Stephen:
Letter to the SEC from Massachusetts Governor Deval Patrick,
dated September 17, 2013................................... 136
Letter to the SEC from the Massachusetts Municipal
Association, dated September 9, 2013....................... 138
Chandoha, Marie:
Written responses to questions for the record from
Representative Ellison..................................... 140
Written responses to questions for the record from
Representative Hultgren.................................... 143
Stevens, Paul Schott:
Written responses to questions for the record from
Representatives Garrett and Sewell......................... 147
EXAMINING THE SEC'S MONEY
MARKET FUND RULE PROPOSAL
----------
Wednesday, September 18, 2013
U.S. House of Representatives,
Subcommittee on Capital Markets and
Government Sponsored Enterprises,
Committee on Financial Services,
Washington, D.C.
The subcommittee met, pursuant to notice, at 10:05 a.m., in
room 2128, Rayburn House Office Building, Hon. Scott Garrett
[chairman of the subcommittee] presiding.
Members present: Representatives Garrett, Hurt, Neugebauer,
Westmoreland, Huizenga, Grimm, Stivers, Mulvaney, Hultgren,
Ross, Wagner; Maloney, Sherman, Lynch, Moore, Perlmutter,
Scott, Himes, Peters, Ellison, Watt, Foster, Carney, and
Kildee.
Ex officio present: Representative Hensarling.
Chairman Garrett. Greetings and good morning. This hearing
of the Subcommittee on Capital Markets and Government Sponsored
Enterprises is hereby called to order.
Today's hearing is entitled, ``Examining the SEC's Money
Market Fund Rule Proposal,'' and I thank all the members of the
panel for being with us today. We will be looking to you for
your comments in a moment.
I also thank the members of our committee who are here to
examine this important issue.
We will now have opening statements, and I will begin by
yielding myself 6 minutes.
Following the events of the financial crisis, in which some
of the money market funds, as you know, experienced heavy
investor redemptions, the SEC had proposed a rule for which the
stated intent was making money funds less susceptible to future
runs and improving the transparency of money market fund risk.
The process leading to the SEC's current rule proposal
reflects the good, the bad, and the ugly of agency rulemaking.
In fact, it is really a tale of two different rules.
The first iteration of that would become a current rule
proposal considered by the SEC more than a year ago, as a
cautionary example of agency rulemaking gone wrong, both in
terms of process and substance.
As SEC Commissioner Dan Gallagher described it, the
original proposal was presented to the Commission by the then-
SEC Chairman as, ``inviolate fait accompli, having already been
fully-baked and blessed by other agencies without the input of
the Commissioners and lacking in adequate economic analysis.''
But thanks to the efforts of Chairman Issa and his staff on
the House Oversight and Government Reform Committee, we are now
able to construct a picture of what appears to have been a
wildly, closely coordinated effort by the SEC Chairman and FSOC
and the Federal Reserve to develop the substance of the
original rule proposal and to exert undue political influence
on the Commission to accept it.
To highlight just one example, documents obtained by
Chairman Issa's committee appeared to show certain individuals
of the SEC working together with the Fed to draft a letter for
FSOC back to the SEC, pressuring the Commission to adopt
specific money fund reform measures, and then dangling the
possibility that FSOC would take those matters into its own
hands.
This collaboration appears to have occurred well before the
Commission was even set to vote on the original rule proposal.
Then, after the original rule proposal ultimately failed to
gain the support of the majority of the SEC Commissioners
necessary to bring the matter to a vote, what happened?
The FSOC doubled down, again pressuring the SEC to act on
specific money market fund reforms by issuing and seeking
comment on its own reform recommendations. So, given the
significant intrusion of banking and systemic risk regulators
in the SEC process, it should come, then, as no surprise that
the focal point of the original rule proposal was a requirement
that money market funds implement what is commonly called
capital cushion, or buffer.
So while this capital buffer requirement was reportedly
designed to make money market funds better able to withstand
heavy redemptions during times of market stress, I believe that
it was, and it continues to be, an entirely inappropriate
option for money market funds.
First, money market funds are fundamentally a securities
product. And I believe the consumer should think of them as
such. Forcing money market funds to hold bank-like capital will
only foster the false perception and impression among many
investors that these funds are more like federally-insured bank
accounts and security products.
Second, as the SEC itself has since concluded, the capital
buffer contemplated in the original rule proposal would likely
be insufficient to absorb very large losses on the level
experience during the financial crisis. But a buffer high
enough to do so would be too costly to be practical.
And third, as Commissioner Gallagher has pointed out, the
only real purpose for the proposed buffer was to serve as the
price of entry into a emergency lending facility at the Federal
Reserve that they could construct during any future crisis.
In short, the buffer would provide additional collateral to
provide a Fed bailout to the troubled funds.
With the Obama Administration's precedent-setting bailouts
of the auto industry and Fannie Mae and Freddie Mac, costing
literally billions of dollars, we simply cannot afford to
extend yet another taxpayer-funded bailout, and the moral
hazard that goes with it, to money market funds.
When rulemaking is done correctly, it is a deliberative and
thoughtful process based off of hard economic pattern.
Fortunately, the second iteration of the SEC's money fund
proposal, the rule proposal that we are going to be taking a
look at today, seems to be more in line with that standard.
The current rule proposal sets forth three alternatives, in
addition to certain enhanced dislosure requirements, and I will
run through them.
First, it has a floating net asset value (NAV) requirement
for specific types of money market funds called prime
institutional funds. Second, it has mandatory liquidity fees
and discretionary temporary redemption gates for all
nongovernment money market funds during the times of market
stress. And third would be a combination of these two
alternatives.
So, unlike the original proposal, the current proposal was
informed by the results of a study of money market funds
conducted by the SEC's division of economic and risk analysis,
which show the heaviest redemptions during the financial crisis
were where? In the prime institutional funds.
Moreover, I was pleased to see that the current rule
proposal does not include a capital buffer or alternative that
enshrined taxpayer bailouts and makes security products look
more like bank products.
I believe that the decision to exclude a capital buffer
from the SEC's current rule proposal is very much an important
step in resisting the push to remove substantially all of the
risk from security products.
It is what ultimately hurt investors by reducing their
ability to generate much-needed returns on their investment and
their retirement dollars.
And so, while I may not necessarily agree with every single
aspect of the SEC's current proposals, and I am sure we will
hear from the panel today, and recognize that many of the
important questions remain outstanding, I appreciate the SEC's
commitment to engage in a thoughtful and deliberate process
this second time around.
Ultimately, I believe it is critically important that we
strike the right balance between ensuring that money market
funds can survive during periods of market stress, and
preserving their role as an important investment and cash
management tool for all types of investors. To that end, I do
look forward to a robust debate this morning on the positive,
and the negative, of the SEC's proposals.
And with that, I yield to the gentlelady from New York,
Mrs. Maloney, for 5 minutes.
Mrs. Maloney. I thank the chairman for holding this
important and timely hearing, and for doing so in such a
bipartisan way. Nearly 50 million investors use money market
funds, which collectively hold about $2.9 trillion in assets.
This is a huge market, which is why this issue is too important
to get bogged down in the usual partisan politics.
The SEC has put forward a thoughtful proposal to reform
money market funds, and it deserves a serious discussion. To
encourage this, the chairman and I have tried to ensure that a
broad range of views are represented on the panel today, and I
very much look forward to your testimony and to the debate that
follows.
Before we get into the SEC's proposed reforms, it is
important to remind ourselves why reform is needed. On
September 16, 2008, the Reserve Primary Fund, a $62 billion
money market fund that had invested in Lehman securities, broke
the buck, meaning the value of its shares fell below $1.
This was only the second time a U.S. money market fund had
ever broken the buck in U.S. history. This event sparked a
massive, and I would say terrifying, run on the money market
fund. Never has my phone rung so much off the hook in the
middle of the night, during the day, ``run on the funds, are we
going towards a depression, what is happening,'' but by the end
of the week, investors had withdrawn over $300 billion from the
prime fund, and on September 19th, just 3 days later, really 2
days later because they didn't announce they broke the buck
until the end of the first day, the Treasury Department and the
Federal Reserved bailed out the entire money market industry by
effectively guaranteeing over $3 trillion of money market
shares.
I think it is safe to say that obviously, we do not want
this to happen again, and we look forward to working together
to prevent it. To its credit, the SEC in 2010 adopted some very
substantial money market reforms which include the quality of
the securities that money market funds can hold, and
established minimum liquidity requirements for money funds.
However, as the SEC noted at the time, the 2010 reforms did
not address the fact that money market funds are still
susceptible to devastating investor runs that can destabilize
the entire financial system.
The question before us today is what reforms are needed to
prevent future runs on money market funds. In June, the SEC,
under the leadership of Chair Mary Jo White, issued a proposed
rule that is intended to answer this question. The Commission
proposed two alternatives, both of which take into account the
considerable progress the SEC made with the 2010 reforms, and
they are both narrowly focused on the problems that emerged in
2008.
While most of the attention is focused on the SEC's
floating NAV proposal, I am interested in the witnesses'
thoughts on the so-called ``gates and fees'' proposal. Are
liquidity fees a strong enough deterrent to prevent runs, and
would the prospect of going 30 days without access to your
money prompt investors to withdraw their funds at the first
sign of any trouble? These are two questions I would like
answered in your testimony today, and I look forward to
exploring other questions during the hearing.
Thank you for being here, and I yield back.
Chairman Garrett. The gentlelady yields back. The gentleman
from Virginia, Mr. Hurt, is recognized for 2 minutes.
Mr. Hurt. Thank you, Mr. Chairman. I want to thank you for
holding today's subcommittee hearing to examine the SEC's
proposed rules for money market mutual funds. I know our panel
will provide their views on the SEC's current proposal, but my
concerns also extend to the process by which we came to this
proposed rule.
After former SEC Chair Schapiro was unable to pass a money
market fund proposal through the SEC, the FSOC inserted itself
into the rulemaking process by proposing its own guidelines
pursuant to its authority under the Dodd-Frank Act.
This action by the FSOC raises concern for the development
of financial regulation in the future and carries significant
consequences for government and industry. Congress entrusts
financial regulatory responsibility to specific regulatory
bodies with specific areas of expertise and jurisdiction. Here,
the SEC has overseen the regulation of money market funds for
decades, and it understands the product best. Presumably,
Congress did not establish FSOC's authority under Section 120
as a means for a new regulatory body to undermine the decisions
of the specialized, independent regulatory agency.
Additionally, as a Commission dominated by political
appointees, FSOC, armed with this authority, has the ability to
pressure regulators whose actions do not align with the current
Administration's views. FSOC remains outside of the
congressional appropriations process, further allowing for this
potential politicizing of financial regulation outside of
appropriate congressional accountability.
Finally, FSOC is proposing its money market fund rules did
not establish guidelines for future uses of their enhanced
authority, thereby leaving the door open to the possibility of
numerous encroachments in the regulatory purview of other
financial regulatory agencies.
Ultimately, independent agencies with five members must be
allowed to work their will. The FSOC's authority leaves the
offending regulatory body, in this case the SEC, with the
choice of yielding or being forced to implement a final
rulemaking designated by FSOC on any topic, let alone money
market funds.
Either option lessens the effectiveness of regulatory
agencies that are directly accountable to Congress, and
ultimately, to the American people. I want to thank our
witnesses for being here today. I look forward to their
testimony, and I thank you, Mr. Chairman.
I yield back my time.
Chairman Garrett. Mr. Lynch?
Mr. Lynch. Thank you, Mr. Chairman. And I thank the ranking
member, as well.
I would also like to thank the witnesses for their
willingness to come before the committee and help us with our
work. Today, we are looking at a proposed rule by the
Securities and Exchange Commission to impose a floating net
asset value on prime institutional money market funds, create
liquidity fees and redemption gates when a fund falls well
below the healthy liquidity levels, or some combination of
these two things. But before we talk about the rule itself, I
think it is important to remember why the reforms are so
necessary.
First and foremost, money market funds are an important
cash management and investment tool for a variety of investors,
and they serve an important role in the overall financial
landscape as an alternative to big banks. However, as the
ranking member pointed out, in September of 2008 when the
Reserve Primary Fund broke the buck, we all realized that there
were fundamental structural flaws in the industry that made it
susceptible to runs.
To stop that run, which could have sent the economy off the
cliff, the Federal Government stepped in and guaranteed
investments in those funds, exposing taxpayers in an unexpected
and troubling way. So, we need to find a better way to prevent
the kind of panic that caused a run on the money market funds
back then, but also that preserves the important role that they
play.
The SEC issued a rule in 2010 which made money market funds
more stable and transparent by improving the liquidity and
credit quality of the securities that those funds hold, and
this was a good first step, but I support the SEC's efforts to
continue to address the weakness in the money market funds
exposed by the financial crisis.
The SEC rule we are examining today is narrowly targeted at
the weakness exposed by the crisis, while trying to preserve
the retail funds and government funds which perform relatively
well under that stress. I think that is probably the right
approach, however I am concerned that some of the definitions
the SEC uses to separate prime institutional funds from retail
funds and government funds may have a negative effect on local
governments that rely on those money market funds.
I hope the witnesses here today will help the committee
understand the effect that this rule will have on municipal
government financial ability because this area of money market
funds played an important public role that we may want to
preserve. Thank you, Mr. Chairman, I yield back.
Chairman Garrett. Mr. Hultgren for 5 minutes.
Mr. Hultgren. Thank you, Mr. Chairman.
Thank you all for being here.
Having served in local and State government before my time
in Congress, I do want to recognize the direct and immediate
impact the SEC's reform could have on municipal finance, as my
colleague has mentioned as well. Money market funds provide a
unique and widely-used municipal cash management product that
may no longer be available as the DNA of money market funds has
changed.
I am also concerned that the SEC's inclusion of tax-exempt
municipal money market funds will drive away money market
investors, dampening these funds' interest in municipal
securities. Currently, over 50 percent of outstanding short-
term municipal debt is held by money market funds. If this
demand dries up, municipalities will see higher issuance costs.
Finally, I share some concerns highlighted in testimony
relating to the SEC's effective subsidy of Federal Government
debt. Excluding Treasury and GSE debt from the proposed reforms
isn't bad, but giving these products special treatment only
enables the Federal Government's fiscal irresponsibility at the
expense of States and localities.
I welcome the witnesses' testimonies, and I thank the
chairman for holding this hearing. I yield back.
Chairman Garrett. The gentleman yields back the time.
Mr. Perlmutter, the gentleman from Colorado, for 2 minutes.
Mr. Perlmutter. Thanks, Mr. Chairman.
And to the witnesses, thank you for being here.
My first comment is in response to the chairman and to Mr.
Hurt. The oversight council is doing what it is supposed to do,
which is to oversee a financial system and to look for places
where there may be problems and bumps and humps and all of that
sort of stuff.
And so to the process, I disagree with the gentlemen in
terms of their opening. I also would say, just as a matter of
record, any assistance to Fannie Mae and Freddie Mac came at
the end of the Bush Administration, so it wasn't an Obama
bailout.
Now, to get to the substance of the rules, I would like
testimony today about the floating net asset value proposal,
because I think we actually floated that. It was floated 3
years ago.
And from my perspective, having watched the reserve fund
break the buck, then pursue bankruptcy, which the SEC then had
to oversee, folks didn't get a dollar back. They got something
less than a dollar. And because of the securities-type nature
of the investment, I think they got what they deserved.
And so I know the effort here is to mark everything each
day, and if something is worth 95 cents that individuals know
that, but they know going in that they are buying a security.
Disclosure was part of the rule as it was written 2 or 3 years
ago. So I don't know that having a floating net asset value
changes the picture very much.
And even though I approve and I applaud the process where
the oversight council was participating in this rulemaking, I
think that is appropriate, I would just say that I am not sure
that this answer is--and this rule is going to make any
difference.
Chairman Garrett. And finally, for the last word, I
believe, Mr. Scott.
Mr. Scott. Thank you, Chairman Garrett. First of all, let
me welcome Mr. Steven McCoy, who is the treasurer of the great
State of Georgia. It is good to have you here. Say hello to the
folks back home.
First of all, I do want--I think Mr. Perlmutter really put
his finger on it in terms of the floating net asset value. And
what we are talking about here is a net asset value per share
instead of a value of $1 per share price.
Now while proponents of a floating net asset value claim,
as I understand it, that it would make markets more flexible
and allow funds and markets to remain open and functioning
during a crisis--that is basically that argument, and I
appreciate that.
But we must also at the same time be sure to address
concerns that such a reform would eliminate prime money market
funds, and State and local governments in turn would lose a
valuable tool in money management and would drive up the cost
of financing short-term borrowing. That to me seems to be the
crux of where we are.
What I think what we need to reach for here is a delicate
balance where we can accommodate both. I just simply want to be
able to keep regulations in place that are strong, that are
effective, that protect our consumers, while at the same time
being able to quickly respond to the ever-changing economic
climate and justify a policy accordingly where needed.
And so, I think that is our challenge today. I think we
need a delicate balance. I yield back.
Chairman Garrett. The gentleman yields back. And before we
go to--the gentleman from Georgia just entered. While he sits
down, I just wanted to, without objection, enter into the
record a letter from the Financial Services Roundtable on this
topic, and also a letter from the Mutual Fund Directors Forum.
Without objection, it is so ordered.
If the gentleman from Georgia is prepared, we have I
believe another minute for the gentleman.
Mr. Westmoreland. Thank you, Mr. Chairman. And I want to
take a moment to welcome Mr. Steven McCoy, the treasurer of my
home State of Georgia. It is always good to see a Georgian
represented on the panel. I look forward to your testimony on
how the SEC rules impact the way Georgians invest their hard-
earned money as taxpayers.
The subject matter of this hearing might be technical, but
for me the bottom line is we need a broad array of financial
products for investors of all shapes and sizes to choose. With
the Federal Reserve depressing interest rates for savers, many
retail and institutional investors choose money market funds
because they provide a better return on investment.
Congress, the SEC, FSOC, and yes, even the bank regulators,
must pursue regulations and policies that create diverse,
liquid financial markets. I urge careful consideration of all
the unintended consequences of this rule. I yield back.
Chairman Garrett. The gentleman yields back, and I thank
the gentleman.
So now, we turn to the panel. There is a gentleman who has
been recognized twice now for your work in Georgia, the
treasurer from the State of Georgia, Mr. McCoy, you are
recognized. I know most of you have been here before, but I
always restate this.
You are recognized. You will be recognized for 5 minutes,
and we ask you to make sure that when you speak, you pull your
microphone as close as you can, so that we can hear you. Make
sure the light is on. And of course, as you all know, you have
5 minutes. The yellow light gives you a one-minute warning, and
the red light means you are out of time.
So Mr. McCoy, you are now recognized for 1 minute.
STATEMENT OF THE HONORABLE STEVEN N. McCOY, TREASURER, STATE OF
GEORGIA, ON BEHALF OF THE NATIONAL ASSOCIATION OF STATE
TREASURERS (NAST)
Mr. McCoy. Thank you, Chairman Garrett, Ranking Member
Maloney, and members of the subcommittee. On behalf of NAST, I
thank you for providing us the opportunity to testify on the
SEC's proposed money market fund reforms.
NAST is a bipartisan association. It is comprised of all
State treasurers and State financial officials throughout the
country. Treasurers, given their role within each State of
ensuring proper cash management, do have a unique perspective
on money market fund regulation, and we appreciate being able
to share our perspective on this.
Money market funds are an important investment tool for
many State and local governments throughout the country. They
rely on money market funds as short-term investments that
provide liquidity, preservation of capital, and diversification
of credit risk.
But then also, as we have heard in the Congressmens'
statements, they are very important to State and local
governments since we are issuers of short-term debt. And the
short-term debt--the municipal money market funds are the
largest purchasers of short-term debt. And any reform that
would limit the attractiveness of money market funds to
purchase municipal bonds would--and reducing the demand would
increase our financing costs.
But additionally, and the place I would like to spend the
most of my time today, since I think the other panelists are
going to deal with the purchasing of money market funds, the
two primary issues of floating NAV and liquidity in gating, and
also with municipal money market funds.
But one of the things that I would like to focus on is
local government investment pools. Most States have created
them over the years. They go back over 30 years with a history
of pools. And they are a safe and efficient method of investing
State and local government funds.
Changes to the regulation of money funds, even though local
government investment pools (LGIPs) are not registered with the
SEC, that still these reforms could indirectly impact our
operation and viability because GASB has two regs, 31 and 59,
which require externally-managed pools to be 2a-7 light in
order to use amortized cost accounting and preserve a stable
NAV.
So what I would like to do is just focus on the potential
impact on LGIPs of the proposed regs. LGIPs operate for the
exclusive benefit of governmental entities within each State.
They are distinguished from money market funds in that they are
not open to the public.
Instead, LGIPs serve only governmental entities that
otherwise would have difficulty investing public funds safely
and efficiently. This is both large and small government
entities that, while these State statutes governing LGIPs
differ, LGIPs generally accept deposits from cities, counties,
colleges, school districts, authorities, public hospitals, and
various commissions and boards.
In some cases, like Georgia, we also commingle the State's
short-term assets in our local government investment pool to
create economies of scale so the local governments can benefit
from the economies of scale that we use, and they can also
benefit from our credit research and our experienced investment
officers.
LGIPs are often used by participants to invest funds that
are needed on a day-to-day basis or on a near-term basis. And
so even though they are exempt from SEC regulation under the
Investment Company Act of 1940 because of sovereign ownership,
the SEC's proposed changes could have some unintended
consequences that would indirectly impact our ability to
continue to offer these safely and efficiently.
For instance, converting an LGIP to a floating NAV or
imposing liquidity fees and gatings, both would be in violation
of many of the States' statutes, and also prudent investment
policies. As government entities, we cannot tolerate loss of
principal on operating funds, trust funds or bond proceeds
because we have no method of replenishing losses.
So we have to be very careful to preserve capital and have
liquidity. We need it to make--so liquidity constraints,
preservation of capital and preservation of liquidity is very
important to us. That we cannot accept liquidity constraints
that could prevent us from funding or local governments from
funding critical public needs, of paying debt or other
obligations when due.
Local government investment pools hold money, provide an
attractive yield, and provide liquidity so that all
participants know their money is there and available and safe.
Some may point to bank deposits as an alternative, but States
typically require collateral on bank deposits. And so those--
they have to be collateralized sometimes, in our State for
instance, at 110 percent with marketable securities.
So the cost associated with collateralizing public bank
deposits limits many banks from providing competitively-priced
alternatives. Also, the availability of eligible collateral
will limit the amount of bank deposits, collateralized deposits
that banks, especially in smaller communities, would accept.
In wrapping up, I would like to say that we appreciate the
opportunity. We have asked that the SEC include a comment just
that they do not intend this to be applicable to LGIPs. Thank
you, sir.
[The prepared statement of Mr. McCoy can be found on page
84 of the appendix.]
Chairman Garrett. Thank you. And now, we welcome back Ms.
Sheila Bair, the former Chair of the FDIC, who is now Chair of
the Pew Charitable Trusts, Systemic Risk Council. Welcome once
again to the panel. And you are recognized for 5 minutes.
STATEMENT OF THE HONORABLE SHEILA C. BAIR, CHAIR, SYSTEMIC RISK
COUNCIL, AND FORMER CHAIR, FDIC
Ms. Bair. Thank you, Chairman Garrett, and Ranking Member
Maloney. As a number of Members have noted, 5 years ago this
week, the Reserve Primary Fund, a massive money market fund
that held just 1.3 percent of its assets in Lehman Brothers
debt, announced it would break the buck, and the financial
markets froze.
In just 2 days, the $62 billion fund received requests from
investors to return approximately $40 billion of their money.
The money fund quickly depleted cash reserves and tried to sell
assets. This not only further depressed the value of its
holdings, but depressed the value of other money market mutual
funds as well.
Because the Reserve did not have capital or a deep-pocketed
parent who could subsidize its losses, the fund had to reprice
its shares going from $1 to 97 cents. Reserve investors waited
months for full access to the remaining cash and, based on
recent press reports, the dispute between the SEC and the
Reserve is still ongoing.
The run on Reserve, however, quickly spread to other money
market funds. During this week, 5 years ago, investors withdrew
$310 billion from prime money market funds.
To meet these requests, other money funds, just like the
Reserve, began to sell more securities into illiquid markets,
further reducing their values and putting other money funds,
stable $1 NAV, at risk.
Many sponsors subsidize their funds to defend the $1 NAV.
Further fearing redemptions, many funds limited new investments
to cash, Treasuries, and overnight loans.
U.S. corporations and municipalities seeking to access the
short-term markets for cash were out of luck. Short-term
interests rates spiked and credit markets froze.
On September 19th, the government stepped in with massive
and unprecedented taxpayer support. The Federal Reserve created
a special liquidity facility to aid money market funds and the
Treasury Department used the Exchange Stabilization Fund (ESF)
to guarantee trillions of dollars in shareholders' money fund
holdings.
Almost every money fund opted to this after-the-fact
insurance policy created almost overnight by the Federal
Government. While the bailout worked to calm the short-term
markets in 2008, Congress prohibited the Treasury Department
from again using the ESF to guarantee money funds.
And while some modest reforms were put in place in 2010,
the core structure risk and money funds that nearly brought the
financial system down in 2008 still remain and threaten our
financial system today.
The core structural risk is a special SEC rule that allows
money funds to price their shares at one dollar even when the
value of their underlying assets is not worth a dollar.
This special treatment called the stable NAV is what makes
money funds different from other mutual funds and so
susceptible to destabilizing runs. It effectively pays first-
movers to run and imbeds losses on remaining shareholders.
Even if shareholders don't want to run, they do not want to
risk paying for someone else's losses.
While the SEC recently proposed some modest changes to the
structure of money market funds, the proposed reform options
have too many holes and exceptions to adequately protect the
financial system.
One proposed option, the limited floating NAV option, would
leave the structural risk in money funds that cater to retail
investors or invest large portions of their assets in agency
securities, including Treasuries, the Federal Home Loan Banks,
Fannie Mae, and Freddie Mac.
As we know, these assets are not free from risk, but the
SEC proposal is treating them as if they are.
Moreover, this special treatment for money funds that make
investments in those firms over firms that make investments in
other U.S. companies effectively further subsidizes Treasuries,
the Federal Home Loan Banks, Fannie Mae, and Freddie Mac, over
private market competitors.
That is a mistake at a time when the government should be
working to reduce government subsidies which distort capital
allocation. This goes in the opposite direction.
The other ``gates and fees'' approach is actually worse
than current law because it will encourage investors to run
sooner in order to avoid the ``gates and fees.''
A better approach is to treat all money funds like other
mutual funds and require a simple, floating NAV. As seen during
the 2008 crisis, the rigidity and destabilizing effects of a
stable NAV can shut down markets and make crises even worse.
A floating NAV is much more flexible and allows funds and
markets to remain open and functioning in a crisis. Moreover,
while other crises may occur, they would no longer be caused or
exacerbated by the stable NAV.
Finally, a strong floating NAV approach, as outlined in my
written testimony, would help level the playing field for
investment companies and investors by helping ensure that
investment decisions and competitive outcomes are based on the
quality of asset allocation decisions not the moral hazard of
potential sponsor support.
This is the same, simple, regulatory framework that applies
to all other mutual funds, a framework that the SEC has
implemented successfully and without systemic risk or taxpayer
bailouts since 1940. Thank you very much.
[The prepared statement of Ms. Bair can be found on page 52
of the appendix.]
Chairman Garrett. Thank you.
And next, we will hear from Ms. Chandoha, the president and
CEO of Charles Schwab Investment Management, Inc. You are
recognized for 5 minutes.
STATEMENT OF MARIE CHANDOHA, PRESIDENT AND CHIEF EXECUTIVE
OFFICER, CHARLES SCHWAB INVESTMENT MANAGEMENT, INC.
Ms. Chandoha. Chairman Garrett, Ranking Member Maloney, and
members of the subcommittee, my name is Marie Chandoha. I am
president and chief executive officer of Charles Schwab
Investment Management, Inc., the asset management business of
the Charles Schwab Corporation.
Thank you very much for the opportunity to discuss Schwab's
perspective on the SEC's money market fund proposal. Schwab is
one of the largest managers of money market funds, with 3
million accounts and nearly $170 billion of assets.
The vast majority of these assets are held by individual
investors. Approximately 88 percent are held in sweep funds
which automatically invest cash balances while providing
investors with convenience and liquidity.
These sweep accounts allow retail investors to easily buy
and sell stocks, bonds, and mutual funds and also allow them to
write checks and pay bills electronically.
Even in the current environment of historically low yields,
individuals continue to use money market funds as a central
element of their financial lives.
We generally support the SEC's reform proposal. It is a
serious and substantial proposal that strikes the right balance
between reducing the likelihood of runs while also preserving
money market funds as an extremely important cash management
vehicle for individual investors.
We further support combining the two alternatives that the
SEC has proposed requiring institutional money market funds to
move to a floating net asset value and allowing, but not
mandating, a fund's board to impose redemption gates or
liquidity fees if necessary during times of stress.
We believe that redemption gates and fees could be a useful
mechanism for an orderly liquidation of a fund that is in
trouble.
We agree with the SEC that the rule should focus on the
greatest areas of risk by proposing a clear distinction between
institutional and retail investors. Retail money fund investors
have shown no propensity to run. Even in the financial crisis
of 2008, retail investors did not run. Runs have been triggered
by institutional investors who have large amounts of cash in
the funds and who have the resources and technology to redeem
very quickly.
Targeting the area of greatest risk is the goal of any
sensible regulation and we believe that the SEC has achieved
that with their proposal. However, we do think that the
proposed rule has a number of areas that can be modified in
order to maintain the viability of this crucial investment
product for the individual investor.
Let me make two brief points. First, municipal money market
funds should continue to have a stable NAV. These funds are
much more liquid than prime funds and therefore much more
resistant to runs.
Both the SEC's analysis and our own experience shows these
funds have been resilient in times of stress. Even in the midst
of the 2008 financial crisis, municipal funds did not
experience the redemption levels of prime funds.
Second, the tax problems related to a floating NAV must be
resolved before implementation so that investors are not forced
to track and report hundreds of capital gains and losses. That
would be an administrative nightmare for taxpayers.
While we support the proposal, the rule is likely to result
in significant outflows from prime money market funds. On one
hand, this will reduce the size of the industry which
ultimately reduces the systemic risk, but it is not clear where
the outflows would go as investors still need to invest their
cash.
Some would undoubtedly flow to government and Treasury
money market funds, but there is some question as to whether
there would be enough of these type of securities to absorb the
inflows.
We also want to observe that the cost of implementation and
the potential impact of the reforms on the financial system are
both significant. We urge the SEC to carefully analyze whether
these costs are outweighed by the benefits.
In our comment letter, we list some recommended changes
that would ameliorate some of these costs while still achieving
the policy goals of this reform. Even with these changes, the
costs remain significant.
In closing, let me be clear. The SEC has proposed a serious
set of reforms that will have enormous ramifications for the
money fund industry. They will be costly for Schwab and other
firms to implement, and they represent a fundamental overhaul
of a product investors of all types have relied on for more
than 4 decades.
But we do support the proposed reforms because they are
targeted at the most serious risks. Other regulators have
called for a one-size-fits-all approach that would destroy the
product for individual investors. We believe the SEC has found
a tough yet pragmatic solution that will boost investor
confidence, deter destabilizing runs, and ensure that
individual investors can continue to rely on this critically
important product. Thank you very much for inviting me to
testify, and I look forward to answering your questions.
[The prepared statement of Ms. Chandoha can be found on
page 59 of the appendix.]
Chairman Garrett. Thank you.
Next up, for 5 minutes, we will hear from Mr. Gilligan, who
is representing the U.S. Chamber of Commerce.
STATEMENT OF JAMES P. GILLIGAN, ASSISTANT TREASURER, GREAT
PLAINS ENERGY, INC., ON BEHALF OF THE U.S. CHAMBER OF COMMERCE
Mr. Gilligan. Good morning, Chairman Garrett, Ranking
Member Maloney, and members of the subcommittee. I thank you
for the opportunity to discuss the potential impact of the SEC
proposal on money market funds on the business community.
My name is James Gilligan, and I am the assistant treasurer
of Great Plains Energy Incorporated, which is the holding
company of Kansas City Power & Light Company and KCP&L Greater
Missouri Operations Company based in Kansas City, Missouri. Our
electric utilities serve over 830,000 homes and businesses in
47 counties in Missouri and Kansas.
I also serve as the chairman of the Association for
Financial Professionals Government Relations Committee, and I
am here today testifying on behalf of the U.S. Chamber of
Commerce and the thousands of corporate financial professionals
who are tasked with managing their companies' cash flows and
ensuring that they have the working capital and liquidity
necessary to efficiently support their operations.
There are several important points I wish to stress to the
subcommittee today. Money market funds have existed for over 4
decades. These funds are used by businesses throughout the
United States to meet their cash management and short-term
funding needs.
They are an integral part of a tightly interwoven system
for low-cost, short-term business financing of unrivaled
liquidity and efficiency. This system has served the American
economy well, and provides a competitive advantage for American
businesses in global markets.
The Chamber and the corporate treasury community believe
that the major rule changes to money market mutual fund
regulations that were implemented in January 2010 were well-
conceived and strengthened the product to withstand significant
market stress.
As the SEC considers moving forward with additional
regulation, it is incumbent on the Commission to take a
balanced and data-driven approach to further strengthen money
market funds while preserving the critical role they serve for
U.S. businesses and nonprofit organizations. If the floating
NAV proposal is adopted for institutional prime money market
funds, it would fundamentally alter the product, eliminating
stability and liquidity, the key attributes that attract
investors.
Thus, money market funds would no longer remain a viable
investment option to many treasurers and financial
professionals. Consequently, with fewer investors and less
capital to invest, money market funds would no longer remain a
significant purchaser of corporate commercial paper. The
reduced demand would drive up borrowing costs significantly by
forcing companies to fund their day-to-day operations with less
efficient and more costly alternatives.
Currently, Great Plains Energy offers interest rates to
investors on our commercial paper in the current range of 30 to
70 basis points.
If, instead, we had to use our revolving credit facilities
with our banks for overnight borrowings, those borrowings would
be priced at the prime rate, plus a spread, which at current
rates, is at least 3.3 percent, or 330 basis points--10 times
higher than where we can place overnight commercial paper.
In addition, the company would be required to borrow at
least $1 million, whereas commercial paper can be sold in
increments of $100,000; and to request a more comparable LIBOR-
based borrowing from our bank group would require 3 days prior
notice, have a minimum term of 30 days, and be for a minimum
amount of $5 million, and it would still be at a rate of about
125 basis points higher than our commercial paper for the same
term.
This is a cheaper option, but again, it is up to 4 times
more expensive than commercial paper.
The SEC's proposal acknowledges that a floating NAV will
not necessarily reduce the risk of widespread redemptions
during times of market stress, and given the uncertainty as to
whether this proposal will protect against a run on money
market funds, we believe it is inappropriate to implement the
proposal since it will undermine the value and key attributes
of money market funds while driving up costs drastically.
The Chamber does support greater transparency with respect
to the holdings of money market funds and the daily disclosure
of a shadow NAV that many funds currently report--provide
investors with the benefits of a floating NAV without
jeopardizing the viability and utility of money market funds.
In conclusion, the cost of the floating NAV far outweighs
the benefits and is another case of where the medicine may kill
the patient. This concludes my statement and I am happy to
answer any questions. Thank you.
[The prepared statement of Mr. Gilligan can be found on
page 72 of the appendix.]
Chairman Garrett. Thank you.
And finally, from the Investment Company Institute, Mr.
Stevens is recognized for 5 minutes.
STATEMENT OF PAUL SCHOTT STEVENS, PRESIDENT AND CHIEF EXECUTIVE
OFFICER, THE INVESTMENT COMPANY INSTITUTE (ICI)
Mr. Stevens. Thank you, Chairman Garrett, Ranking Member
Maloney, and members of the subcommittee. It is a pleasure to
be with you this morning.
The SEC rulemaking that you are examining really is vitally
important to some 61 million individual investors, and
literally thousands of institutions in our country, including
businesses, State and local governments, and nonprofits that
depend, today, on money market funds as a low-cost, efficient
cash management tool, and one that provides a high degree of
liquidity, stability of principal value, and a market-based
yield.
For 5 years, ICI and its members have worked diligently
with the SEC, with the Congress, and with other regulators to
develop ideas about how to make money market funds more
resilient under even the most adverse market conditions.
I would observe that the SEC has 40 years of success in
regulating these funds. Its expertise and its experience mean,
in our judgment, that the Commission is in the best position to
implement any further reforms.
In our work on money market funds, we stress two principles
consistently. First, the reforms should preserve the
fundamental characteristics that make money market funds so
valuable to investors and to the economy, as you have heard on
the panel this morning.
And second, that we should preserve choice for investors by
insuring a continued robust and competitive money market fund
industry.
Now, applying those two rules to the SEC's rulemaking,
those two principles, I would offer 5 summary conclusions. By
the way, I would note for the subcommittee's benefit, we did
file yesterday about an 80-page comment letter on these, so
this is, in fact, just the top line.
First, we agree with the Commission that there really is no
reason to apply structural changes to funds that invest
primarily in Treasury or other government securities--
collectively, government money market funds.
Second, funds that invest primarily in short-term debt of
State and local governments should be exempted from these
structural changes. The characteristics that the SEC attributes
to government funds apply with equal force to those of tax-
exempt municipal funds.
There is no evidence that investors in tax-exempt money
market funds redeem en masse during periods of market stress.
Moreover, these funds hold the great majority of their assets
in highly liquid securities that can be liquidated to make
redemptions.
Experience also shows that credit deterioration in
securities issued by one jurisdiction does not tend to affect
other jurisdiction's securities. Given the vital role that they
play in financing State and local governments, tax-exempt funds
should not be subjected to disruptive and expensive structural
changes.
Third, in discussions with our members and their
shareholders, one thing has become crystal clear--combining the
SEC's two proposals would render money market funds entirely
unattractive to investors.
The Commission's proposals, in effect, confront investors
with a choice: sacrifice stability, in the case of floating net
asset values on prime institutional funds; or face the prospect
of losing liquidity under extreme circumstances, through the
proposal for liquidity fees and redemption gates.
We have found that some investors place more of a premium
on principal stability, while others value ready access to
liquidity more strongly. But, and I want to emphasize this,
virtually every ICI member tells us that no investor would
purchase a floating value money market fund that was also
subject to constraints on liquidity. Investors have, frankly,
other less onerous options readily available to them.
Fourth, if regulators do feel that it is necessary to
require some money market funds to float their values, it is
critical that we address the significant burdens on investors
in the tax and accounting treatment of gains and losses. This
will require action by Treasury, the IRS, and perhaps even by
the Congress.
Unless these issues are resolved in advance, investors are
unlikely to accept floating value money market funds and
significant disruption of short-term credit markets is highly
likely.
And fifth, we support the Commission's recognition that its
proposal should be appropriately targeted, and that funds
intended for retail investors should be exempt from any
requirement to impose floating NAVs. We have significant
concerns, however, about the practicality and costs of the
SEC's proposed definition of retail funds, based on daily
redemption limits.
Instead, we recommend the use of Social Security numbers as
the fundamental characteristic to identify investors eligible
to invest in retail funds. This approach would be far less
costly than other methods of defining retail funds and far
easier for investors to understand.
In the 5 years since the financial crisis, the fund
industry has strongly supported the SEC's efforts to make money
market funds ever more resilient, even as they continue to play
their valued and important role for investors in the economy.
We appreciate deeply the support that many members of this
committee and subcommittee have shown for our efforts. I look
forward to your questions.
Thank you, Mr. Chairman.
[The prepared statement of Mr. Stevens can be found on page
111 of the appendix.]
Chairman Garrett. Thank you. And I thank the panel.
We will now go to questions, and I will recognize myself
for 5 minutes.
And I will start, I guess, with Mr. McCoy. My general
question is going to be what your opinion is of the effect of
these rules on municipal money market funds; but, something you
brought up during your testimony with regard to the LGIPs, and
you said something about the banks that are--is there is an
overcollateralization requirement? So, can you answer both of
those questions, just quickly on the overcollateralization?
Mr. McCoy. Yes. On the collateralization requirement,
there, local investment pools no longer could remain 2a-7
like--
Chairman Garrett. Yes.
Mr. McCoy. --to be stable value. One of the alternatives a
lot of people look at is moving money into banks.
Chairman Garrett. Right.
Mr. McCoy. The problem is, banks have to post collateral in
mark-to-market daily to secure public deposits. And at 110
percent level, the cost of the bank, both has to be a bank that
is willing to accept a public deposit, pay some rate of
interest comparable to any other investment; but also, the
availability.
We have found, recently, two colleges, as their deposits
grew larger, working with a smaller community bank, they did
not have collateral sufficient to cover those deposits, and
they did ask that the accounts be moved to larger banks.
Chairman Garrett. Okay, I can agree with that--
Mr. McCoy. Probably in a lot of smaller communities, there
are not banks available--
Chairman Garrett. I get where you are going. Okay.
Mr. McCoy. And then, on the other, on the municipal money
market funds that we have, we do feel like that municipal
security--short-term securities, should receive the same
treatment as the U.S. Government obligations, as to have an
exemption for them in that they are not retail funds. A lot are
institutional investors, so they cannot qualify under the
retail exemption the SEC has proposed. So, we have asked that
they receive an exemption.
Chairman Garrett. All right, great. Thank you.
Ms. Bair, you raised the point--an interesting one with
regard to if you have the gates and the restrictions on there
that may accelerate the withdraws, right?
Can't a thing be said, or can't it be said with regard to a
floating NAV that if you have a floating NAV as the investor
sees it--``oops, it is down, it broke the buck, so to speak,
and all of the sudden, that is my first cue to pull out as
well,'' so is one worse than the other?
Ms. Bair. That is going to be true with any mutual fund.
Frequently, what you find what you get into downturned
situations is that people take their money out of lots of
mutual funds. They reprice, they go into Treasuries, they fly
to safety.
The issue is whether the government is going to give them
an incentive to run. And so with the stable NAV, they are,
because you are a smart, one of the so-called smart money and
you are seeing, ``Oh, the assets in this fund are only worth 97
cents, I can still get out at a dollar--I am going to go out.
The government is giving me an affirmative incentive to run.''
Chairman Garrett. Okay.
Ms. Bair. That is the inherent source of instability.
Chairman Garrett. Another question--another point you
raised during your testimony, do you believe now that the law
would prohibit a bailout, if you will, and assure of the funds?
Ms. Bair. I do.
Chairman Garrett. Okay. That is because of--
Ms. Bair. Because of the--yes, that was put into law--was
it the TARP legislation, I think--
Chairman Garrett. Yes.
Ms. Bair. There is a specific statutory ban, and remember
ranking others have affirmed--
Chairman Garrett. So, what about--
Ms. Bair. It has no intention to bail them out, they don't
feel like they have authority to--
Chairman Garrett. Yes, well, they don't have any intention
to bail out of things.
So, what about under Section 13.3, would they be--if they
were not an individual firm or--but as a same last time, if it
is systemic to the entire economy and the Fed identifies an
entire industry that needs to be preserved or protected under
13.3, wouldn't they have the authority to do so there?
Ms. Bair. If it is generally available, that is right. But
there are special prohibitions for money market funds. So, I
think, that is really--
Chairman Garrett. So, it is a question of which law
prevails, whether they--with the prohibitions, or--
Ms. Bair. I don't know. I think that the more--the greater
likelihood is if we leave this structural instability in place,
and we have another problem, they are going to be coming to
Congress and asking you to vote for a bailout.
That is what is going to happen, because I don't think they
feel like they have the authority to do it, and so, it is going
to be on Congress' head, to vote or not. This is the way it was
in court and a lot of you face some tough reelections; some of
you lost those, because of that vote.
Chairman Garrett. Okay. So many more questions. Can you
kind of speak to the issue?
Mr. Stevens, I think you brought it up with regard to the
shadow NAV, and the effect--the positive effects that could
have, and the transparency element, and I guess if you want to
do them and you answered one of my questions already, would
simply transparency, and I know--
Would simply the transparency aspect of the rule and
putting in some temporary limitation gates be adequate?
Mr. Stevens. If I could take the first part of that, I
really would recommend to the subcommittee a report that Dennis
Beresford, who is a former Chairman of the FASB, has prepared.
And it examines how we maintain a stable NAV and money market
funds. It is done through something called amortized cost
evaluation of the securities in the portfolio.
Amortized costs is an accounting convention which is 40
years old. It is not a fiction; it is a convention. In fact, it
is a convention that Ms. Bair has recommended very strongly be
applied to the banking industry. But apparently in our context,
it is not a convention, but a fiction. The reality is that as
Beresford's report points out, the mark-to-market value of
these portfolios fluctuates from $1 only infinitesimally on
average, maybe a basis point or so up and down.
So the value is, in fact, I think a reality, and
Beresford's report makes it clear that this is a fair way to
value money market funds. It is not a fiction.
Chairman Garrett. Okay, I am going to try to contain my
time as I do with everybody else, so I appreciate that motion.
If you can give me some further answers on the rest of the
questions, I would appreciate it.
Mr. Stevens. I would be happy to, Mr. Chairman.
Chairman Garrett. The gentlelady from New York is
recognized.
Mrs. Maloney. Thank you. On the liquidity fee proposal, of
the fees that are intended to deter investors from withdrawing
their money in times of stress, and I would like to ask James
Gilligan, in the SEC's proposal, the maximum size of the
liquidity fee would be 2 percent, and as an investor, do you
think a 2 percent liquidity fee would be enough to deter you
from withdrawing your money during times of crisis?
Mr. Gilligan. Recall in my testimony, I am not a net
investor, so this is speculation on my part, but I think that
liquidity gates and redemption limitations are not palatable to
corporate treasurers in any sense of the word, and they would
not be attracted to investing in money market funds to begin
with.
That is our point, that this could destroy the product of
money market funds and have repercussions that are far more
extensive than what are being contemplated by imposing that. I
don't frankly know if a 2 percent liquidity limit will keep
people from redeeming or not. They are not going to like that
there is going to be a gate on their redemptions, period.
Mrs. Maloney. There is some proposal to raise the amount
that the 2 percent is not doing the job of, Ms. Bair, you
testified that this would not help, that this would make the
problem worse. Do you want to elaborate, and Mr. Stevens, your
comment on this too?
Ms. Bair. I do think it would make it worse. The prospect
of the agencies will again give affirmative incentive to people
to get out before the gates and fees go down, and I worry that
again, that is going to be the more sophisticated investors who
understand what is going on.
That is why you saw retail not running, although I don't
know that we can assume that won't happen again. One of the
reasons retail didn't run is because the government quickly put
a program in place, but they are going to be left, because, so
a product that is designed for giving people the impression
they have ready access to their cash, that their cash is fully
protected, all of a sudden they are going to have to pay a lot
of money to get their money out or perhaps even have to wait 30
days. But I think from an investor perspective, that is very
ill-advised.
And the thought, I think the industry is being somewhat
inconsistent by suggesting that as a good approach. On the one
hand they say, ``Well, this is a very, very important market,''
which it is. It is a huge market, despite potentially
destabilizing. But on the one hand, they say, ``this is very
important,'' but then it is okay to lock it down for 30 days,
and not let people pay their bills or make their payroll or
whatever. That makes no sense to me, so I think this is not a
good option. I hope the SEC drops it. It is an alternative to
the floating NAV, and I think it is very ill-advised.
Mrs. Maloney. And Mr. Stevens, your position on the
liquidity and fees?
Mr. Stevens. Thank you, Mrs. Maloney.
The reality is that the SEC staff report agreed with us in
our recommendation with respect to the consideration of the
liquidity gates and fees, that if you cast your mind back to
2008, it is the recommendation that would have stopped a
cascade of redemptions.
But I would say that in the industry, no one would wish to
flirt with the triggers that would impose those gates or those
fees. As the SEC has conceptualized it, if a fund's weekly
liquidity falls to 15 percent of its portfolio, it would then
be required to consider these two measures. That would mean
that weekly liquidity had fallen by 50 percent.
The requirement, if it were adopted into a rule that would
be internalized by portfolio managers across the industry,
would be to stay very well north of 15 percent liquidity. In
fact, if you look across taxable money market funds today,
their required weekly liquidity is $700 billion. Their actual
weekly liquid assets maintained in their portfolios as of July
was $1.3 trillion.
Mrs. Maloney. And I would like to get Mr. McCoy's comment
on this, and also, does anyone know where these fees go? The
rule was very vague in where these fees go. Where do they go?
Does anyone know? Just in the general Treasury? It doesn't say
where it goes.
Ms. Bair. They go back into the fund.
Mrs. Maloney. Pardon me?
Ms. Bair. They go back to the fund.
Mrs. Maloney. They go back to the fund, and would be
distributed among the other people?
Ms. Bair. Yes.
Mrs. Maloney. Mr. McCoy, your position on the--
Mr. McCoy. I know that is correct on money market funds.
There is a concern on most of investment pools as to who we
even legally impose liquidity fees, or gates in that could we
actually take money from some local governments that are
behaving one way, they want their money out, and pay it to
others that are staying in.
Mrs. Maloney. And on the floating NAV, can anyone estimate
the average variability in the NAV of time funds if the SEC
adopts the floating NAV plan. What does it mean? If it is near
$1 or near $10, would they shift to that area? Any comments--
Mr. Stevens. Can I take a try at it? Actually, in order to
force these funds' portfolios to float, for their NAVs to vary,
the SEC is actually proposing a valuation method which is not
characteristic of mutual funds, generally. It would require
these funds to basis point round their portfolios 4 places to
the right of the decimal. That requirement is intended to force
a float which the normal pricing of mutual funds' experience
would not display.
So it shows you the portfolios here are really quite
stable, and in order to make them float at all, the SEC has to
depart from what is the convention with respect to other funds.
Mrs. Maloney. Thank you. Any other comments?
Chairman Garrett. No, and with that, the gentleman from
Virginia is recognized.
Mr. Hurt. Thank you, Mr. Chairman. I wanted to ask Chairman
Bair, who obviously is very familiar with what happened in 2008
and was on the ground, if either or both of these proposals
were in place in 2008, can you kind of walk us through what you
think would have been the effect, and whether or not this would
have had, either of them would have had a positive effect, why
or why not?
The second thing I was hoping you could also offer up is
your view of how this regulatory proposal fits into what is
being developed overseas and in other countries, and how that
affects our competitiveness?
Ms. Bair. Right. So I think the gates and fees would have
made it worse. I think the floating NAV--look, if we never had
this special SEC rule that allows a stable NAV, I don't think
you would have seen such a huge shadow market develop. I don't
think you would have seen other financial institutions that
were relying on short-term money, so I think if we had that,
the money fund industry from the get-go would be smaller, and I
think it would have behaved like other money funds.
You would have seen a lot of redemptions. You would have
seen a flight to quality. You see, that is how markets work.
They reprice in times of stress, but no, I don't think we would
have had or seen the implosion that we had in 2008.
This proposal, I believe, is weaker than what they are
talking about in Europe. They are saying do a floating NAV or
have 3 percent capital. If you want to have a stable NAV, you
want to promise your investors you are going to have a dollar
no matter what, put some capital behind it. They are saying 3
percent, so--
Mr. Hurt. So what is your view of the effect of our
competitiveness, and what is available to the folks that Mr.
Gilligan is speaking for in terms of having an efficient
marketplace, and being able to have the most choices for the
least cost?
Ms. Bair. So look, implicit government subsidies always
allow people to do business more cheaply. Guarantees of that
capital behind them always allow people to do business more
cheaply, but those models work until they don't, and they don't
work in times of distress. So I think you need to think how it
works in good times, which is it saves everybody money, and how
it works in bad times, when it costs taxpayers, we know it did
cost or forced them to take a lot of risk. Fortunately, it
didn't end up costing anything.
So I think that those are the tradeoffs you have to make,
and again Europe is being tougher, and they don't seem to be
worried about putting themselves in a less competitive position
to us.
Mr. Hurt. I also wanted to ask Ms. Chandoha, Mr. Gilligan
and Mr. Stevens about what Mr. Gilligan testified to, and that
was that the floating NAV proposal would deprive significant
choices and impose significant costs.
Ms. Chandoha, you testified that clearly the imposition of
these rules or the floating NAV proposal would lead to
migration out of money market funds. How do you respond to that
concern that the cost is greater than the benefit at the end of
the day? Are you able to respond to that, and then I would love
to hear follow up from Mr. Gilligan and Mr. Stevens on that
question.
Ms. Chandoha. We really feel the 2010 reforms strengthened
the money fund industry, but there still remain some perceived
risks in the money fund industry. We think the SEC has taken an
approach to identify the remaining areas of risk in the money
fund industry, and we feel that the proposal will have an
impact on corporate treasurers. I think there was an eloquent
discussion of that, and we do think that there will be
shrinkage of the industry. So there will be some costs, but it
will reduce some of the perceived risks of the industry.
Mr. Hurt. Okay.
Mr. Gilligan. My response is, the floating NAV is not a
solution to what I think the problem is that is trying to be
solved, which is a run on money market funds.
I implore everyone to consider, even if you go back to
2008, when the reserve fund broke the buck, and we had a flight
to quality from investors who withdrew significant amounts of
money from money market funds--all money market funds. The
commercial paper market froze in 2008. So, that is an example
that I hold out to you of what I think will happen to money
market funds for different reasons.
You impose these new regulations, they make them
unattractive to investors, you will see them move funds out of
the money market funds. You will see a complete freeze-up of
the commercial paper market, like we saw in 2008, which will
drive companies like mine to higher-cost alternatives, which
will have an immediate impact on borrowing costs--which, in our
industry, will eventually--
Mr. Hurt. Thank you.
Mr. Gilligan. --get passed down into our rate payers--
Mr. Hurt. Got it.
Mr. Gilligan. --and out of the pocketbooks.
Mr. Hurt. Thank you, Mr. Gilligan.
Mr. Stevens, I apologize, but my time has expired.
Chairman Garrett. The gentleman yields back.
Next, Mr. Ellison is recognized for 5 minutes.
Mr. Ellison. Thank you, Mr. Chairman. And I wanted to thank
all the panelists.
Ms. Chandoha, I have a question for you. And I want to
thank you for being here today.
In 2011, Schwab became the first and only brokerage to
insert clauses into your customer service contracts banning
your customers from participating in any class-action lawsuit
against your company. This is in addition to the requirement in
your agreements, which is also used by other brokerages,
mandating that disputes with individual clients be settled
through arbitration.
Your regulator, FINRA, is challenging the legality of your
class-action waiver as a violation of its member rules. And I
believe your firm issued a statement on your Web site on May
15th--which I can't locate now, by the way--announcing a
temporary suspension of the practice pending the resolution of
the FINRA action against you.
My question is why Schwab, alone among brokers, feels that
its clients should have to give up their right to participate
in its class actions?
Ms. Chandoha. I run the Asset Management Subsidiary of the
Charles Schwab Corporation. The broker-dealer is a different
subsidiary, so I am not the right person to answer that
question. I am not very familiar with that particular issue.
But we can certainly have someone get back to you on that, and
answer that question.
Mr. Ellison. I would appreciate that. I would just like to
put a few other questions on the record for you. Maybe you can
answer them, maybe you can't. But I would like to also know why
Schwab can't put an end to this practice of not allowing their
customers to participate in any class-action lawsuit.
And then also, if Schwab is successful in stopping FINRA's
legal challenge, is Schwab planning to re-insert the class-
action waiver into the account agreements? Are those questions
you can answer?
Ms. Chandoha. Those aren't questions that I can answer, but
we will certainly take those questions back, and we will have
someone get back to you on that.
Mr. Ellison. And also, I am curious to know if Schwab is
going to re-evaluate whether taking away the right to go to
court is fair to customers. So, I assume you can't answer that
question, but I assume also that you will bring it back to the
people who can.
Ms. Chandoha. Yes, we will.
Mr. Ellison. And I would also just like to express my
concern about small investors having access to the courts.
Putting aside the question of whether or not it is legal, I
would like to know whether you believe, or whether you can get
back to me on whether or not you believe it is fair for small
investors to be forced to waive all rights to go to court to
settle disputes before a dispute even occurs or can be
understood against a company of significant size such as
Schwab?
Again, I am sure, this is for the record, and I am urging
you to take it back. And I also want to express my concern that
Charles Schwab believes it can establish a trusted relationship
with clients while requiring every single one of its clients to
give up its legal rights to go to court before they can work
with you.
So, I would like to just put those questions on the record.
I will submit them to you in writing. And I just want to make
it clear that this is an issue I am quite concerned about.
Actually, we have crafted some legislation to address the
issue. And I just want to underscore that we believe that the
small investor needs to have a voice, and our concern about the
practices in which Schwab is engaged.
So, thank you for being as responsive as you can today. But
please convey to your colleagues this is an ongoing issue, and
this is not going to be dropped.
Also, I would like to point out that I think this whole
issue underscores why Congress sought to restrict the use of
these contracts in Dodd-Frank, Section 921, and why we probably
should have gone further. And it is also, again, why I
introduced H.R. 2998, the Investor Choice Act, which would
prohibit such forced arbitration contracts, when used by
brokers to abridge the rights of their clients.
And so, Mr. Chairman, whether by statute or the legislation
or rule, the Federal Government has a duty to see that
arbitration is not abused, and that investor rights are not
further eroded by these types of clauses in broker-dealer
contracts.
So, thank you.
I think I have--I am on my yellow light, so I would like to
direct a question to Chairwoman Bair.
Could you offer your views, ma'am, on how you would
evaluate this proposed rule from the SEC with the three
proposed reform alternatives set forth by the Financial
Stability Oversight Council?
Mr. Hurt [presiding]. Mr. Ellison, what I am going to do
is, I am going to ask that the witness respond in writing. And
if we have time at the end, we can--
Mr. Ellison. Oh, yes. I see we are at the red light--
Mr. Hurt. So, time has expired.
Mr. Ellison. Thank you. I yield back the time I don't have.
Thank you.
Mr. Hurt. Thank you, Mr. Ellison.
Next, Mr. Stivers is recognized for 5 minutes.
Mr. Stivers. Thank you, Mr. Chairman. And thank you to the
witnesses for being here.
I want to follow up on something that the chairman of the
subcommittee asked before he left. And I would like all the
witnesses to sort of go down and give me their view of this
issue.
I believe that a floating net asset value will actually
exacerbate the problem, because it will encourage people to
redeem as soon as possible, because the risk is that your money
will be worth less tomorrow, or 5 minutes from now, or
whatever.
So, I guess I want to ask all the way down the panel what
your view is on that. I believe it makes the problem worse, not
better, as far as rush to redemption. Could each witness tell
me their opinion on whether they think it makes the problem
better or worse?
Mr. McCoy. We believe it would make the problem worse. And
as institutional investors, we are concerned that it would make
the problem worse. We also believe that the nuances of daily
pricing--it will create some problems and confusion in the
marketplace. It does not give time for any pricing errors to be
reconciles and mitigated before damages are done.
And so, we do think there are a lot of issues. We think it
would make the problem worse.
Mr. Stivers. Thank you.
Ms. Bair. A floating NAV would make the problem--it deals
with the core problem, which is that, with a stable NAV, if it
is only worth 97 cents, you can pull out of the dollar. You are
given an affirmative incentive to run.
Markets reprice all the time, but if you get with a
floating NAV, if you get it out, you will have to take a loss.
Ms. Chandoha. We do think a floating NAV will increase the
transparency. Schwab voluntarily chose to disclose our shadow
NAV's earlier this year, so we do think that helps
transparency, and reduces the surprise factor. So, if there is
a discrepancy between the--
Mr. Stivers. My question is, will it increase the race to
redemption, not does it increase transparency. Could you answer
that question?
Ms. Chandoha. Yes. I do think it helps mitigate the run
risk.
Mr. Stivers. Okay.
Mr. Gilligan. I agree very strongly with you, sir. And
also, I would echo the comments of Mr. McCoy.
Mr. Stevens. We actually saw during the financial crisis
funds that had floating net asset values per share experience
massive redemptions. French money funds that had variable NAV's
experienced them. Short-term bond funds in the United States
experienced them.
And more generally, we think that what happened with the
Reserve Primary Fund was not attributable to its ``breaking a
buck.'' It was a flight to quality. It was a flight to
Treasuries and other quality instruments that was
characteristic of the broad market.
Two-thirds of all the dollars that flowed out of U.S. prime
funds during that period flowed into Treasury and government
agency funds. So, I don't think it was a fear of the ``breaking
the buck.'' It was a general preference for safer assets. And
if the Reserve Primary Fund had been floating at the time, you
still would have found that a factor.
Mr. Stivers. Thank you.
Ms. Bair, if the floating net asset value results in a
massive change in the size of the money market mutual funds
market, which it probably will, from, say, $3 trillion to $1
trillion, and $2 trillion flows into banks that are government-
insured with a government guarantee, doesn't that exacerbate
the too-big-to-fail problem we have?
Ms. Bair. The deposit limit is $250,000, so those are going
to be uninsured deposits. And I don't know if that is where it
is going to go. I am skeptical of some industry, not every
one--some industry's predictions that this is going to result
in a massive downsizing of the money fund industry. There will
be some downsizing.
Mr. Stivers. But there is a government guarantee up to
$250,000.
Ms. Bair. Up to $250,000. And there is also--the banks--
unlike the--banks aren't perfect. And I am not singling out
money funds. There are a lot of reforms I would like to see
with banks. The deposits--we do not have a systemic problem
with deposits. Deposits have not run. Because we have a whole
elaborate system of deposit insurance of access and Federal
reserve lending. Banks have to hold capital and unsecured debt,
which by statute, take first loss before you can get to
deposits.
So, that part of the banking system works well.
Mr. Stivers. But it makes the banks bigger if the funds
flow to the banks? That is correct, isn't it?
Ms. Bair. If those deposits flow into banks, yes, it will.
Yes.
Mr. Stivers. Thank you.
The next question I have is for the two treasurers, Mr.
Gilligan, and then the State treasurer, about what would
happen--what would you do if you didn't have a stable net asset
value in money market mutual funds? Would you be able to use
them to invest in?
Mr. Treasurer?
Mr. McCoy. At the State of Georgia, our focus would be--
because--at the local governments cannot invest in straight and
in privately managed money market funds. They can invest in the
State and local government investment pool.
If we could not operate the stable value, we would explore
how to operate as a stable value.
It may not be a 2a-7 light fund, but we could not under the
current State laws, and I don't think it would be prudent to
change our State laws to take away the preservation of
principal as a top priority to actually move to a floating NAV.
So we would explore how to restructure local government
investment pools, as I think other States would too.
I think also I would like to comment--
Mr. Hurt. Mr. McCoy?
Mr. McCoy. --on your other question. Banks are--there are
also--
Mr. Hurt. Mr. McCoy?
Mr. McCoy. --bank stiff funds.
Mr. Hurt. The time of the gentleman has expired. Thank you
for your answer. The Chair now recognizes the gentleman from
California, Mr. Sherman, for 5 minutes.
Mr. Sherman. Thank you, Mr. Chairman. I realize it is a bit
unfair to my colleagues to just walk in right before it is time
for my questions. I just arrived at the airport half an hour
ago. It was pretty meaningless anyway.
In crisis circumstances, the funds may have been worth
quite a bit different than the exact $1. But today, how big is
the variation? Are we talking about every fund being between a
dollar and a tenth of a penny or minus a tenth of a penny? Or
if we really knew the shadow NAVs, how big a difference is
there? Chairman Bair?
Ms. Chandoha. I can answer that question. The variability
is very minuscule. It is out several decimal places and is in
the range of a tenth of a penny. So, it is very tiny.
Mr. Sherman. But if you have $10 million to invest and you
just have to move your money from a fund where you are down a
tenth of a penny per dollar over to a fund where you are up a
tenth of a penny per dollar, if you have $10 million, that--
Ms. Chandoha. There are very few funds right now which are
below a dollar. Most funds are above a dollar.
Mr. Sherman. Above a dollar by more than a tenth of a
penny?
Ms. Chandoha. In that range. But it is very, very small
around a dollar.
Mr. Sherman. Could we meet the needs for stable investment
vehicles if we had a fixed dollar on U.S. Government investing
funds, Mr. McCoy?
Mr. McCoy. For governments, no. Local governments and State
governments, no. In fact, we would run into a problem if it was
a government-only fund during a period like we had last
September, I think it was September 28th, when Treasuries went
into negative rates for a short period of time when there was a
flight to quality.
We cannot buy a security that would have a loss in
principal. And so actually when you have negative interest
rates, which we have seen in some European countries and we
have seen for one day in U.S. short-term Treasuries, that they
really would not be even applicable or eligible for us to
purchase.
Ms. Bair. I think--was your question with this, a stable
NAV with government funds, would that actually meet the need of
having payment processing which would be less risky than prime
funds? And I think that is a question--
Mr. Sherman. Yes. Thank you for restating the question.
Mr. McCoy. But from our perspective, it would be that we
could not necessarily manage a local government investment pool
with government only and meet the qualifications because we may
have to--
Mr. Sherman. Because of what?
Mr. McCoy. Because the requirement of the amount of U.S.
Treasuries that we would have to keep short, if we see a flight
to quality that we--for instance, managing a local government
investment pool, some of the--
Mr. Sherman. If I can interrupt, are you referring to
circumstances where the government paper has a negative yield?
Mr. McCoy. That is one. Also, we do have some other
requirements for State governments in managing pools. For
instance, our bank deposits would not qualify. So there are a
lot of issues with local government investment pools that is
not an option.
Mr. Sherman. Does anyone else on the panel have a comment
on that?
Ms. Bair. I think that is a great question. As I say, I
think there are significant downsides to letting--using a
stable NAV for government funds which I articulated in my
testimony.
But I do think for those who suggest that the SEC's
proposal is somehow going to disrupt the ability of large
corporations or municipalities or whatever to have a place
for--with a stable NAV for payment processing, they could use
government funds under the SEC proposal. I think that is a good
thing to note.
Mr. Sherman. Okay. I want to yield the rest of my time to
the gentleman from Massachusetts.
Mr. Lynch. Okay, thank you. This is going to be a great
opportunity. First of all, I want to thank all of the
panelists. You have offered some very thoughtful testimony
here.
Ms. Bair, in your expanded written testimony, you really do
point to the stable NAV as the culprit and the inducement to
run. Now if Mr. Stevens and what my colleague Mr. Sherman has
suggested, if this differential is very small, isn't that an
insurable risk?
If the delta is so small, why can't we have insurance for
those parties investing in these funds so that if we did bump
up against the dollar the insurance would kick in? There
wouldn't be an inducement to run. The delta would be insured
and we wouldn't have the flight to quality that we see now, or
am I just moving the goal post?
Mr. Hurt. Mr. Lynch, I think your time has expired. Mr.
Sherman's time has expired. What I would like to do is
recognize Mr. Hultgren for 5 minutes, and then the witness can
answer your question.
Mr. Lynch. Sure, that's great. Okay, fair enough. Thank
you.
Mr. Hurt. The gentleman from Illinois is recognized for 5
minutes.
Mr. Hultgren. Thank you, Mr. Chairman. Thank you all for
being here again. I think this is a very important topic that I
certainly want to understand, and I know my colleagues do as
well.
And just to recap, I think my understanding is pretty clear
from your testimony, from the questions that certainly for
investors two of the most attractive features of money market
funds are stable NAV and also liquidity.
It also seems fair to say that these features, if they are
compromised by floating the NAV or imposing gates or fees, we
would likely see--most of you had said this--we would see money
flow out of the products and we would see less demand for money
market funds.
Mr. Stevens, I wondered, this movement out of money market
funds, would that also be seen in institutional prime funds as
well as municipal funds?
Mr. Stevens. I think it would be across-the-board, assuming
that the requirements were applied uniformly, particularly if
they were applied in combination. And we have given a lot of
thought over these past 5 years to where the money would go.
One of the convictions I think, particularly for retail
investors, is that it would flow into bank deposits and
probably be concentrated in the largest of our banks. With
respect to institutions which have more alternatives, there are
private funds that they could use. There are offshore vehicles
that they could use. None of them have the transparency or the
regulation that are characteristic of today's money market--
Mr. Hultgren. Treasurer McCoy, if I can ask you a quick
question, if we expect an exodus of investors from municipal
tax-exempt funds, couldn't this mean a cost spike for State and
local government financing?
Mr. McCoy. It would. Anything that would reduce the demand
for our issuance of bonds would increase our borrowing cost.
Mr. Hultgren. So it is really--the potential is the new
rules could indirectly burden our constituents, the taxpayers,
with highest costs for States and municipalities. Is that true?
Mr. McCoy. Absolutely. It would drive up our borrowing
costs.
Mr. Hultgren. Okay. Mr. Stevens, jumping back to you,
quoting from your testimony, the SEC--as you stated--released
proposals to exempt government money market funds from further
structural reform because of, among other things, the
following: Government money market funds are not susceptible to
the risks of mass investor redemptions. Their securities have
low default risk and high liquidity, and interest rate risk is
generally mitigated.
Could the same be said of municipal funds as well?
Mr. Stevens. Yes. In fact, we believe that the municipal
security market reflects many of those same characteristics. In
addition, we have looked at the Detroit bankruptcy, the
experience in September of 2008, and the problems in Orange
County historically and have discovered that those major shocks
in the market did not precipitate outflows en masse from tax-
exempt money market funds.
Mr. Hultgren. Ms. Chandoha, in your testimony, I gather
that you would agree with ICI's conclusion that municipal money
market funds are particularly resilient, to quote your
testimony, and don't pose a systemic risk. Is that true?
Ms. Chandoha. That is true. I agree with what Paul said,
that the municipal money funds are much more liquid than prime
funds, so they are far more resilient. They proved that in the
financial crisis. We didn't really see flows there.
They are also--they represent 10 percent of the whole money
fund industry, so they are very small relative to the entire
industry, but yet have outsized importance for State and local
governments to finance themselves.
Mr. Hultgren. Okay. Treasurer McCoy, I wonder if you could
help me further understand. I have met with some State
treasurers, but I want to ask if you could briefly lay out the
implications of the SEC's proposal for local government
investment pools, or LGIPs.
The LGIP structure won't be familiar to everyone here, and
I believe the effects of the SEC's alternative proposals
certainly could pose a significant risk to participants in
LGIPs, potentially harming the finances of those municipal
entities. Could you tell us just briefly--I only have a few
seconds left--if you see this as a potential harm and a concern
we ought to have?
Mr. McCoy. I think every State that manages an LGIP would
look at this very seriously.
I think that we will--as State treasurers, we would work
with GASB to see if we could encourage GASB to change their
rule to be more like the office of the OCC rule for bank stiff
funds, which does describe--or require a stable NAV by using
amortized cost accounting. So it would, we would be moving in
that direction to see if we couldn't get some relief there.
Mr. Hultgren. My time is about to run out. I am going to
ask if I can follow up with some written questions and ask for
your response. One in particular is NAST, concerned with the
SEC's proposed elimination of the 25 percent basket, returning
to a 10 percent limit, effectively could cap municipal debt
held by a single MMF regardless of creditworthiness.
So I have some questions about the impact, again, on
taxpayers, on our constituents. My time has expired, and I
yield back. Thank you all very much.
Mr. Hurt. The gentleman's time has expired. And the Chair
now recognizes Mr. Lynch for 5 minutes.
Mr. Lynch. Thank you. Again, if I could go back to my
question, Ms. Bair, it is sort of two dimensional. One is,
would we be able to ensure the risk of breaking the buck to
remove that inducement to run?
And the other is, by creating an insurable situation there,
you would allow the insurance company to actually look at the
quality of the assets within the fund in setting the insurance
rate. Is that something you had considered? And I do appreciate
the courage of your position. You are not the most popular
person in the room, but I do appreciate your candor, your
honesty.
Ms. Bair. So this would be using a private insurance or
government insurance program?
Mr. Lynch. Either way. The SEC is now talking about fees--
Ms. Bair. Right.
Mr. Lynch. Redemption fees--
Ms. Bair. Right, right.
Mr. Lynch. If you are going to charge them.
Ms. Bair. Right. I think if policymakers decide that we
need the fund industry as it is because of the payment
processing services it provides, especially for large corporate
users and governments, to do it up front with some type of
insurance program that you pay for is the best way to do it.
I am not advocating that, but I am saying if you want this
industry to continue the way it has been, which now has an
implicit government guarantee, frankly, a guarantee without any
capital behind it, nothing behind it except kind of a wing and
a prayer, that would be the way to go.
I am not advocating that, but if you want this industry to
continue the way it is with the stable NAV for a wide variety
of large corporate users in particular, that would be a better
approach than to leave things the way they are.
Mr. Lynch. Thank you. And let me ask you, Ms. Chandoha has
recommended--and again, this is for you, Ms. Bair--in her
testimony that municipal MMFs, money market funds, be exempt
from the floating NAV requirement.
And there is a public purpose in terms of the municipals
that is undeniable, and I worry. I have a letter here from the
Massachusetts Municipal Association. I will ask unanimous
consent to enter that into the record.
And also, a letter from Governor Patrick--
Mr. Hurt. Without objection, it is so ordered.
Mr. Lynch. --arguing against the floating NAV. So, what are
your thoughts on that in terms of exempting them?
Ms. Bair. I don't like the government securities generally,
so I would take it all out. I would say that the argument is
stronger for a Treasury-only fund than it is for GSEs.
And I am sorry you have credit risk with municipal debt,
you do. You certainly have interest rate risk with all of them.
So, no, I would just like to get rid of that exception for
government funds. But I certainly wouldn't want to expand it.
Mr. Lynch. Okay. And, lastly, again, this has been touched
on several times. I just looked at the size of the 10 biggest
banks back in 2008, for those that are still around and a lot
of them are not. On average, they have increased 40 percent in
size between 2008 and 2013.
And I am just concerned about this too-big-to-fail problem.
If we are going to create safeguards, that does induce folks to
get out of money markets, and if they do run to banks, are we
creating even a bigger problem on that end?
Ms. Bair. I don't know where the money would go. I don't
know that it would go to the largest banks. I think, typically,
when I was at the FDIC, we saw a lot of volatility with
community bank deposits depending on where the money fund
rates--returns were.
So, I think there is--definitely if you are worried about
competitive issues, it is not clear to me at all that this is
going to be benefiting the big banks. I would say, though, this
is--
Mr. Lynch. If I could, I think in the money market space,
we have seen the size of sponsors--
Ms. Bair. Certainly, on the retail level--
Mr. Lynch. Influence.
Ms. Bair. On the institutional level--
Mr. Lynch. Yes.
Ms. Bair. Yes, you would assume that very large accounts, I
would assume, would go to the larger banks. For the retail
level, I don't know if that is the case.
So, look, this is not about--I think there is a
perception--or those who want to keep the status quo want
people to think this is bank-driven or bank regulator-driven.
This is system stability-driven. I don't think the big
banks are not supporting this. A couple have weighed in on the
side of the fund industry because they have their own money
funds. They have more deposits than they know what to do with
already. So, I don't think they are driving this. I think what
this is about is system stability. You have a banking system,
albeit imperfect, and it needs changes, too.
But, on the deposit side, it worked pretty well, and the
reason is because you have a number of safeguards like deposit
insurance, like Federal Reserve Board lending, like capital and
unsecured debt that takes first loss before deposits would ever
be hurt, which is why deposits mostly suck even the uninsured
stuff.
So, it is whether you want a shadow bank or not. You have a
shadow bank that works in good times and it doesn't work in bad
times. So, if you want to keep this, then you are right, go
with some kind of government--
Mr. Lynch. Thank you--
Ms. Bair. --insurance program for that.
Mr. Lynch. I yield back. Thank you for your courtesy.
Mr. Hurt. Thank you, Ms. Bair.
The Chair now recognizes the gentleman from South Carolina,
Mr. Mulvaney, for 5 minutes.
Mr. Mulvaney. Thank you, Mr. Chairman.
I fully admit that this is not something which is readily
intuitive to most folks. I am not very familiar with it, so I
appreciate all of you taking the time to help us get up to
speed.
When I deal with things that I don't readily understand, I
like to go back to the very beginning of the issue.
And it strikes me that we are here and the SEC is proposing
these rules, if I get this right, in order to prevent future
runs on money market accounts. That is a fair statement, right?
But yet, I hear Mr. Stevens then turn around and tell me
that there was no run in 2008 on these money market funds,
there was no run when Orange County went under on these money
market funds several years ago.
Mr. Stevens, you are shaking your head no, but I thought
you said that there was no run on these accounts several years
ago.
Is this a solution looking for a problem? Why are we even
talking about these things?
Mr. Stevens. No, I believe, Congressman, what I said was
that the problems experienced in prime money market funds in
2008 have been attributed to one fund breaking a dollar.
Mr. Mulvaney. Right, just one.
Mr. Stevens. Just one. The reality is that before the
Reserve Primary Fund broke a dollar, 13 major financial
institutions had collapsed or required a government bailout.
Lehman Brothers went bankrupt, and the day the Reserve
Primary Fund broke a buck, AIG was taken out. There was not a
characteristic of money funds that was at issue. It was, in
fact, a general flight to quality by all investors in the
market. Remember, in those days, the banks wouldn't even lend
to one another.
So, what we saw is investors, very deliberately, leaving
exposure to commercial paper and other assets that were opaque,
including bank assets, bank-issued debt, and they were moving
instead to the safety of Treasury and government agency
securities, and one of the ways that they did so is by
investing in Treasury and government agency money market funds.
We interpret this to mean that it wasn't a structural issue
with money market funds. It was, in fact, a basic problem in
the commercial paper markets that all investors, including
ours, were reacting to.
So, we certainly had outflows, but the commercial paper
markets were experiencing them across-the-board.
Mr. Mulvaney. Thank you for that clarification.
And to the extent that this is something which needs to be
dealt with, tell me, Mr. Stevens--and I heard Mr. Gilligan say
that a lot of funds have already offered--are starting to offer
shadow NAVs.
We have heard other folks testify today about funds
offering voluntary--or talking about proposing voluntary gates
and fees. Doesn't that voluntary system solve the problem just
as well?
If you had a shadow NAV with voluntary gates and fees,
doesn't that accomplish the same thing?
Mr. Stevens. We think disclosure can go a long way without
having a requirement that we float the NAV to inform investors,
since that is what many proponents of a floating NAV argue, to
make them clear in their own minds that this is an investment
product that can change in value.
Some of our members have voluntarily started to do that. If
the SEC were to require it across-the-board, that is something
we could support.
Mr. Mulvaney. So my understanding is that if you do the
shadow NAV instead of actually mandating it, it does avoid some
accounting and tax issues.
Mr. Stevens. Yes, if you allow the transactional value to
remain stable within the confines of the current rule, what you
have is, you are sparing investors the need to keep track of
infinitesimal capital gains and losses over time. Money market
funds aren't like other mutual funds in the sense that you may
buy a mutual fund, a stock or a bond or a hybrid fund today,
and hold it for a long period of time.
But, for a money market fund, you can be in and out of that
constantly. Certainly, Schwab's customers are a great example
of that, in Marie's testimony.
And if you had a floating NAV, each one of those would have
to keep track of minuscule gains and losses each time and
report them to Uncle Sam. It would be a paper chase nightmare
for tax compliance.
And that is one of the reasons, I think, that money market
funds are so popular because of the convenience that they
provide through that stable $1.00 per share value base.
Mr. Mulvaney. Thank you, Mr. Stevens.
Mr. McCoy, I want to get back to you very briefly. I have
45 seconds left. At the very end of your testimony, you were
saying something very interesting to me which is the impact
especially of these proposed rules on small and rural
communities.
Could you finish that testimony please because that--you
just described most of my district?
Mr. McCoy. Yes, sir. Thank you.
Those will be the communities we think will be most
impacted, that your large metropolitan communities gain great
benefit from local government investment pools, but many of
those could adapt more easily.
They have larger financial institutions in their community
that they have banking relationships with that would work with
them to accept deposits. Also, they do have some trained
investment staff, and with very good systems, they could move
to develop to buy securities directly.
The smaller ones will not have the staff or the resources
to look for alternatives. They will end up taking more
concentration risk in securities instead of having a
diversified portfolio in a local government investment pool.
And often not have banks that would have sufficient
collateral to accept their deposits.
Mr. Mulvaney. Thank you, Mr. McCoy.
Thank you, Mr. Chairman.
Mr. Hurt. The gentleman's time has expired.
The Chair now recognizes the gentlelady from Wisconsin, Ms.
Moore, for 5 minutes.
Ms. Moore. Thank you so much, Mr. Chairman.
I thank the witnesses for appearing here today. I can't
remember if it was Mr. Gilligan or Mr. Stevens who indicated
that were we to float the NAV, there would be a lot of
institutional investors that would flee from the money market
funds and would go to alternative products.
So, you guys are going to have to remind me who said that.
And I guess I would like to know, what that would be? We
have heard a lot discussion here today that they wouldn't
necessarily go to banks. Banks are overcapitalized, they have
record deposits and don't really necessarily want the money.
So, thank you for helping me recall who said that.
Mr. Gilligan. Yes, ma'am. I think I spoke to that.
I think the answer to your question is I don't really know
where these deposits are going to flow to; no one really knows.
Ms. Moore. Would they go off-shore perhaps?
Mr. Gilligan. They definitely could go off-shore. I think
they will go to a number of different places. I think funds
will flow to banks, which has been stated already have a lot of
deposits and have grown in size.
I think there will be some off-shore movement into
nonregulated funds. I think there will be some transition into
muni funds, govi funds, but I don't even know that they are
going--those funds are going to have the capacity or underlying
financial instruments to take the prime institutional money
that will free up--that will move out of there.
So, it is a good question. No one knows.
Ms. Moore. And then, I would ask Ms. Bair, are we pooling
risk into--you said that they wouldn't necessarily go to the
biggest banks, but you acknowledged that they probably would.
Are we just moving risk into government-backed banking
institutions? Wouldn't risk pool there, if it were to go to
those banks?
Ms. Bair. Again, the banking system is made, first and
foremost, for a safe place to put ready cash; cash you need to
move in and out on a quick basis, that maintains stable value--
that is what banks are supposed to do. Money funds are somewhat
of a shadow bank in that regard.
So, the fact that it would go to banks is not--that is what
the banking system is supposed to do. I think Mr. Gilligan has
some good arguments with the suggestion that money fund
investors are going to go to some shadow hedge fund in the
Cayman Islands, it just doesn't pass the lab test.
Money market fund investors are somewhat risk-averse. They
are going to be looking for safe places. And so, I can't
believe that this is going to go into the shadow sector; we
have already talked about Europe, which is proposing tougher
standards. So, I do think he has some good, very good
arguments, which he has articulated very well.
This one, I don't see any shadow banks out there that are
going to be attractive to the kind of investors who put money
in money funds.
Ms. Moore. Okay, thank you for that.
I have a couple of other questions for whoever wants to
answer--feels adequate to answer it, I would invite them to
answer it. Do we have any clarity from the IRS on the
accounting consequences of floating the NAV?
Yes, sir, Mr. Stevens?
Mr. Stevens. Congresswoman, we have had discussions on
behalf of the industry with both Treasury and the IRS. They are
certainly aware of the issues that we have focused our concerns
on if we go to a floating NAV. And, they have tried, at least,
to be forthcoming.
One problem is something called the wash sale rule--if you
are transacting and you are in and out, and you sustain a
period of losses and then you reinvest, they have said that
they would waive the wash sale requirements, but the taxpayer
would still have to keep track of all of the transactions in
order to determine whether they are within the exemption that
is being discussed.
So, the administrative burdens are going to remain. And
while that is at least promising, it doesn't really resolve the
heart of the problem.
Ms. Moore. Right. We are obviously going to see the money
market fund really shrink considerably. And if the only
investors in there would be maybe municipal bonds, who are
treated more like corporate bonds than they are Treasury bonds,
what impact will this have on changing or maintaining the low-
risk profile of municipal bonds?
Mr. McCoy. The question is whether the change on the
municipal bonds--I am trying to make sure I understand the
question--as to the impact on municipal bonds--
Ms. Moore. If they are just a primary customer, as
everybody else is gone--I am assuming that others would leave
and go to big banks--does that change the risk profile?
Mr. McCoy. It would not change the risk profile of the bond
issuers, it would change the appetite of the investors. And--
Ms. Moore. Okay.
Mr. McCoy. So, it would remove the largest purchaser of
tax-exempt bonds if the--if municipal money market--
Mr. Hurt. Thank you, Mr. McCoy.
Mr. McCoy. --demand there are a large purchaser.
Mr. Hurt. Thank you, Mr. McCoy.
Ms. Moore. And thank you, Mr. Chairman, for your
indulgence.
Mr. Hurt. The gentlelady's time has expired.
The Chair now recognizes Mrs. Wagner for 5 minutes.
Mrs. Wagner. Thank you, Mr. Chairman, and thank you to our
witnesses.
This is going to be directed to Mr. Stevens. If the logic
behind the SEC's proposal for floating NAV was simply to
provide more transparency or to remove the unique ability of
money market funds to hold their NAV constant, then I think,
perhaps, the SEC's proposal might have some level of merit.
But, as we know, that is not the primary argument that the SEC
made.
As they noted in their rule proposal, the floating NAV is
designed primarily to ``address the incentive of money market
fund shareholders to redeem shares in times of fund and market
stress.'' The SEC believes that this would, I guess, address
any contagion or systemic risk issues surrounding money market
funds.
So, my question, Mr. Stevens, is does the solution fight
the problem? If there are real concerns about investor
redemptions and systemic risks during times of stress, is a
floating NAV the appropriate response?
Mr. Stevens. We have been on record on this subject
continually since 2009, and it has been remarkable how many
voices there are who say that all we need to do is float the
net asset value per share. Certainly, some voices at the SEC,
and the Federal Reserve Bank Presidents recently have said that
is the prescription.
We have always wondered whether that would stop a massive
redemption out of a money market fund vehicle in the
circumstances that we faced in 2008 when basically, people were
trying to flee from a certain asset class and to find a safer
haven for their investor dollars.
Nonetheless, it remains one of the two core proposals that
the SEC has put in place. And so, our members have been trying
to figure out which is better, from the point of view of the
investors we are serving--a floating NAV per share, or
redemption gates and fees?
Mrs. Wagner. If a floating NAV caused investors to pull
money out of money market funds, is it reasonable to believe
that a lot of the money would flow into FDIC-insured bank
accounts?
Mr. Stevens. We have been on the record about where the
money would go to, and it is a complex analysis. For retail
customers, they really will have no alternative, I think,
except for deposits. So, they will go to banks.
Institutions have lots of other alternatives, and while Ms.
Bair kind of dispenses with the notion that there are offshore
and other kinds of markets, those actually already exist for
institutional investors, and they don't have the transparency,
they don't have the regulations around them.
But if they can provide a current money market rate of
return and a stable net asset value for large investors, they
will be a very attractive alternative to uninsured bank
deposits, for example.
Mrs. Wagner. So, if we are looking at money market reform
from the standpoint of taxpayer protection, the SEC's proposal
could actually create a scenario where funds flow from a
product that currently does not enjoy a taxpayer guarantee to
bank deposits, which have an explicit taxpayer backing. Is that
correct?
Mr. Stevens. We have expressed that concern, as well.
Mrs. Wagner. Wouldn't this end up creating more risk for
taxpayers and perhaps even exacerbate the too-big-to-fail
problem?
Mr. Stevens. It certainly--remember, we are talking about
$2.6 trillion in--that is intermediated through money market
mutual funds today. That is a big number.
And so, if a substantial portion of that were to go back
into the banking system, some substantial portion of that
clearly would be going to our largest banks. I think, to the
extent that raises the concern you are suggesting, it may
create a risk elsewhere.
Mrs. Wagner. Thank you.
Mr. Gilligan, you have an important perspective in this
debate in that you are here representing Main Street companies
that both invest in money market funds but also issue
commercial paper that is bought by money market funds and is
essential to financing operations.
You noted in your testimony that, ``Corporate treasurers
and financial professionals understand the risk of investing in
money market funds, and that investments in these funds is not
guaranteed by the U.S. Government.'' Do you believe the SEC's
proposal for floating NAV will somehow uncover hidden risks of
money market funds that corporate treasurers and other
institutional investors aren't already aware of?
Mr. Gilligan. Absolutely not. And I argue a little bit with
this notion that investors believe there is an implicit
guarantee, anyway, of money market funds. I don't believe that,
and I don't think the majority of investors believe that. Where
that comes from, I don't know.
By definition, institutional investors are sophisticated
enough to understand the underlying risk and the shadow NAV
takes that into account.
Mr. Hurt. Thank you, Mr. Gilligan.
Mrs. Wagner. Thank you--
Mr. Hurt. The gentlelady's time has expired.
The Chair now recognizes Mr. Perlmutter for 5 minutes.
Mr. Perlmutter. Thanks, Mr. Chairman.
Ms. Bair, I don't like being at odds with you. We went
through all of this together 5 years ago today, I think, is
when we began to see a run on money markets. And the reserve
fund broke the buck today or tomorrow, 5 years ago.
So, this net asset value floating--Mr. Hurt asked a
question and I want to just follow up on that--Lehman Brothers
is, say, at 10 o'clock on a Sunday night, is at 20 bucks per
share, and reserve has it as an asset trading; by Monday
morning, it is 2 bucks a share. Okay?
So, in a time of crisis--because that week was Merrill
Lynch, AIG, Lehman Brothers, Wachovia, Washington Mutual and
then the money markets--in 5 days.
The net asset value piece, I don't understand how it makes
a difference. Because all of a sudden, they have gone from $1.2
per value, down to 97 cents. And the net asset value is just
going to tell you that.
My feeling, and I guess I am very laissez-faire on this--
Colorado counties lost a ton of money in the reserve fund. They
went into bankruptcy; they got 93 cents back, Okay?
What different does this make at all when you really are in
a financial crisis like that? I think the insurance that--and I
want to thank you for that--was posted over those couple of
days, that is what stopped the run. Not the fact that people
could say, ``Oh geez, it is 97 cents, I want my money back.''
So, please--
Ms. Bair. So, a couple of things. We had an unstable system
develop because of the stable NAV. We wouldn't have had such a
large shadow banking sector; we wouldn't have had so much
financial institutional reliance on money fund financing to
begin with. So I think there is that.
Plus, I would like to know, why is it that we had to bail
out money funds, but not other mutual funds? This was just a
matter of repricing--
Mr. Perlmutter. Okay, and I get--this is where I disagree,
because it is at $1.2 Sunday night, and at 97 the next morning;
it would have have made any difference. That is what then
created, in my opinion, the run--
Ms. Bair. But there was always repricing, there was always
withdrawal. There were withdrawals in lots of mutual funds. We
didn't have to bail out those mutual funds. What was it that
was unique about money funds that made taxpayers have to come
in and take huge risks that they have--
Mr. Perlmutter. What is unique is they were treated as
checking accounts--
Ms. Bair. Yes.
Mr. Perlmutter. And so the real issue--
Ms. Bair. They are like banking, or shadow bank--
Mr. Perlmutter. As if they are treated as checking
accounts, should there be insurance--not do you mark-to-market
every day.
Ms. Bair. That would be another alternative. That is
something Congress would have to do.
If you want this alternative to traditional banks, if you
want them to have some kind of new kind of bank called the
money fund that is going to have insurance, you will need to
charge for that, and you probably want to have some first-loss
protection like capital, the way we do at banks. Then do that,
if that is what you want, I am not--
Mr. Perlmutter. Or it is buyer beware, and so I guess that
is where I am sort of laissez-faire, because--
Ms. Bair. --if they--
Mr. Perlmutter. Colorado counties took a clobbering.
Ms. Bair. Right.
Mr. Perlmutter. Okay? And if Colorado counties want to
continue to do this, buyer beware.
Ms. Bair. They are--can be--would be--were a lot better if
they see the value of the fund fluctuating every day. It would
be a daily reminder that they are not guaranteed. The stable
NAV--
Mr. Perlmutter. Let me speak to Mr. McCoy. You are watching
these things all the time, are you not as a treasurer? You are
watching the value of your investments?
Mr. McCoy. Absolutely.
Mr. Perlmutter. Every day, so it is more the retail people
I am worried about, and that is why an insurance fund of some
type might be beneficial because it would be like an FDIC fund,
but I just don't think the marking-to-market every day, which
is what the net asset value thing is all about, changes the
equation.
Ms. Bair. But they have to, if they have to sell assets for
redemptions. They have to sell at the market, so that is a much
more accurate reflection of what the value of this fund is
worth. I would just--a lot of people have asked me, and you did
just again.
What would have made the difference if we had a floating
NAV? I think the better question is, what would have happened
if we hadn't had a taxpayer bailout? This idea that there is
only one fund that has ever broken the buck. How many funds
would have broken the buck if taxpayers hadn't stepped in? And
I'm sorry, Mr. Stevens, but your industry was in a bit of a
panic. I was around, and you wanted that bailout, and you
bought into it.
Mr. Perlmutter. You and I are in complete agreement.
Ms. Bair. And I would just like to suggest--
Mr. Perlmutter. Had you and the Administration, and this
was the Bush Administration, not stepped in, it would have
crashed terribly.
Ms. Bair. Yes. And a lot of people would have lost money.
Mr. Perlmutter. I don't think this rule changes that. That
is my point.
Ms. Bair. Okay.
Mr. Perlmutter. No, I am done. Thank you. I yield back.
Mr. Hurt. Thank you, Mr. Perlmutter.
The gentleman's time has expired.
The Chair now recognizes Mr. Scott for 5 minutes.
Mr. Scott. Thank you, Mr. Chairman. I must say, this has
been a very fascinating hearing, because my eyes have been
opened up to something of which I have only been dimly, dimly
aware. Now, from what I have been hearing, is it a fact now
that what we are saying is if this SEC proposed rule requiring
the floating NAV asset value to take the place of the dollar,
that this would kill the prime money market, is that an
accurate statement? Does everybody agree with that?
Ms. Bair. No, I don't--
Mr. Scott. Mr. McCoy?
Mr. McCoy. We figured it would have a significant impact. I
would not use the word ``kill.'' This is something that is new
ground. It is untested, and so we believed it would have a
significant negative impact that would be harmful, but this is
untested.
Mr. Scott. Tell me, what would you do if you could not
invest your money in a market fund at that stable $1 per share,
or you could only invest in government funds? If you had that
choice, where would you put your money?
Mr. McCoy. Yes, for us, the State of Georgia, we are buying
securities directly in the marketplace. We have lots of
alternatives other than money market funds. Your mid and
smaller-sized municipal governments have fewer alternatives and
so a money market fund, for those who can legally buy private
funds, is a very good alternative for them.
Most will--of the local governments would turn to the State
and local government investment pools which are run as stable
value by law, and so that's our issue is that if this has an
unintended consequence that would cause an impact for a local
government investment pool no longer to be able to provide that
service, those local governments, the smaller ones will have
difficult time finding comfortable investments that would not
increase their risk and reduce their liquidity.
Ms. Chandoha. And I would argue that individual investors
have fewer choices, so if they are not going to invest in prime
funds, they could invest in government funds, but the reality
is at this point in time, there is not enough capacity in
government funds to absorb that. We have the largest Treasury
money market fund, and almost 2 years ago we closed that to new
investors because there wasn't enough capacity in that. So we
do think individual investors would migrate probably to bank
products.
Mr. Scott. So what you are saying, then, is it might not
kill the prime money market, but it could put it on life
support. Now, let me ask you, Treasurer McCoy, to explain so
the audience will know why, if it is important operationally
and legally for State and local governments to be able to
transact with money market funds at the $1 level, and what
would be the result, for your failure to do so, how damaging
would that be?
Mr. McCoy. That is a very good question. State and local
governments, and this is separate from our pension funds,
dealing with operating funds, bond proceeds and trust funds, we
have to preserve the public funds, and that's our primary
responsibility, to protect the public funds, and invest them
where they are available as they are needed, State bond
proceeds as they are needed to, or bond reinvestments, to make
payments to bondholders on time, the exact amount that's
needed.
We have to protect funds, operating funds, teachers,
others--employees' payroll. Deposits were made, we have to
safeguard those funds, invest those funds. They need to be
liquid when they are needed for payment.
If anything that would inhibit that would run afoul of the
whole purpose of protecting the public's funds, we do have to
protect the principal and provide liquidity, and that's where
this would run afoul with a lot of State statutes, I know the
SEC just referenced in their comments that States may need to
change their statutes.
That would be a long and healthy debate for States to
determine whether it would be prudent to then put local
governments' money and State government money at risk because
the SEC had changed their money market fund reform, or
regulations, so there--we will have a lot of issues that would
come up, that would impact State and local governments, and
again, these are untested waters.
Mr. Hurt. Thank you. Thank you, Mr. McCoy. The gentleman's
time has expired. Thank you, Mr. Scott.
The Chair now recognizes the gentleman from Illinois, Mr.
Foster, for 5 minutes.
Mr. Foster. Thank you, Mr. Chairman. Do any of you know the
answer to this: Has there ever been an estimate of what the
losses would have been economy-wide had the government not
backstopped the money market industry in 2008?
Ms. Bair. No. No. I don't think they have, but my guess is
it would have been a lot.
Mr. Foster. Or more than $1 trillion, or is there any way
to--
Ms. Bair. That I don't know, but I think a lot of funds
would have broken the buck. I think a lot of retail and
institutional investors would have had to wait a long time to
get their money back, and when they did get their money back
they would have gotten a lot less. Again, as we just said
earlier, some reserve fund investors still haven't been paid,
so I think the results would have been quite cataclysmic, and
hurt a lot of institutional--
Mr. Foster. Those will be the direct losses from investors
who didn't get their money back. There would be a separate
class of losses when the markets froze up, and business as
usual would be--
Ms. Bair. Ironically, the bailout helped the investors, but
money funds still pulled back. They didn't want to lend any
more, and that was why we had problems in the wholesale funding
market. The source of credit that supported other financial
institutions dried up, so while the bailouts protected the
investors, the money funds still pulled back, and that's why we
had, one of the big reasons why we had disruptions in wholesale
funding markets.
Mr. Stevens. Congressman, could I get a word in here, if
you wouldn't mind, because I think you are asking perhaps the
wrong question?
The issue is what would have happened to the economy if the
government hadn't stepped in to try to restore order to the
commercial paper markets? We were an investor in those markets.
We weren't the only investor, and we weren't the only investor
that pulled back. In fact, we re-entered those markets before
most. So the issue is not, as I have said before--
Mr. Foster. You re-entered them after the government
backstopped you.
Mr. Stevens. The guarantee program was in place. That is
correct, and so from a psychological point of view, that was a
very dramatic moment, true. But what ensued thereafter were a
series of programs that the Federal Reserve maintained in order
to get the commercial paper markets starting again.
That wasn't just for our purposes; it was for all
commercial paper, investors' and issuers' purposes, and that is
what got the situation resolved. I think it is important, and I
would like to respond to a statement, if I can do so now, about
the guarantee program.
The guarantee program is not something our industry asked
for. We were told it was going to be put into place. When we
were told it was going to be put into place, we insisted that
it be limited in time. We also insisted that it be limited in
nature. In fact, the guarantee program was designed so that if
a fund broke a buck, the government might pay the difference
between the 99 cents and the dollar, so the exposure was
intentionally limited, and in fact, we paid $1.2 billion in
guarantee fees and the taxpayer never paid a penny on that
guarantee.
Mr. Foster. Does anyone have a comment on your comment
here?
Ms. Bair. We all have our revisionist history. You know,
gee yes, that's right, the government just, for the fun of it,
threw money at money funds when they didn't really need to. I
don't see that the money funds pulling back with its--
disruption wholesale funding markets. There were certainly
other factors, but my own agency ended up having to take huge
exposure guaranteeing the debt of large financial holding
companies who couldn't roll their paper without some kind of
government backstop, so there was quite a lot of government
support thrown at this. And money funds were a significantly
exacerbating factor, and I think anything besides that is
revisionist history.
So, I am sorry we have to have a different perspective on
this, but I was there, and I don't recall anybody objecting in
the fund industry when the government decided to bail them out.
Mr. Foster. Okay.
If I could change the subject for a moment, Ms. Chandoha,
you mentioned that retail investors don't run, which I thought
was interesting. This is, to my thinking, that it was the
sophisticated investors who were the ones who actually monitor
the asset values who actually are the ones who are going to get
their money before the gates slammed shut, or the fund gets
liquidated. Is that really the situation we want to be in, and
one that you think is good for your customers?
Ms. Chandoha. Large institutional investors can lose their
money more quickly. They also hold larger portions of funds.
Mr. Foster. And they monitor--
Ms. Chandoha. So, they can have a much bigger impact very
quickly. Retail investors have very small portions for the
funds. And even if they do move, it has a much smaller impact.
So, there were some redemptions in retail funds, but much
more muted than institutional funds.
Mr. Foster. Yes. And has there ever been research by
independent parties as to what fraction of money market
investors actually understand the risks, and the fact that it
is not just like a checking account?
Ms. Chandoha. We certainly do a lot of education for our
clients. There is a lot of disclosure about the nature of money
market funds. It is a tremendous amount of detail. As I
mentioned earlier, we have been voluntarily disclosing the
shadow NAV's of our money funds since earlier this year. So, we
do--
Mr. Foster. My question is, what fraction of the investors
actually look at those--
Mr. Hurt. The gentleman's time has expired.
Mr. Foster. I yield back.
Mr. Hurt. But I do think that we might have an opportunity,
Mr. Foster, to get back to you if you would like to stick
around.
The Chair now recognizes Mr. Carney for 5 minutes.
Mr. Carney. Thank you, Mr. Chairman, and thank you to all
the panelists. This is a fascinating discussion--question and
answer back and forth. And I have heard a lot of things this
morning that have raised maybe more questions than they have
answered.
For me, I think--Ms. Bair, at one point, you talked--you
posed a question hypothetically--if we want to see a strong
money market fund industry, then you might want to do that. I
get the sense from some of the things that you have said,
directly and maybe implied indirectly, that you think the way
the money--that the money market fund industry is too large.
And you refer to it in a pejorative way as a shadow banking
system.
And I think I understand that, but why do you think it is
too large, or is playing an inappropriate role currently?
I am a former secretary of finance at the State level. So,
I was part of the cash management policy board at the State of
Delaware. I understand the value for State and local
governments on finance committees for nonprofit organizations.
We used money market funds as cash management tools of very
valuable, efficient, convenient way to do those kinds of
transactions.
The implications of what you are saying is that--or this
change, I think, is that people would not see that convenience.
Obviously, there are tradeoffs there, and so they would migrate
to the banks, I think, clearly. And maybe that is a good thing,
maybe that's a bad thing.
I would like to know your view of that. I respect your
opinion considerably, and I would like to know your view on
that point there in terms of going from this way of doing cash
management to--back to the regular banks, if you will.
Ms. Bair. So, what is the core function of a banking
system, any banking system in a developed country? It is a
place where people can put their ready cash. They can access it
at any time, and know it will keep stable value. To provide
that peace of mind, we have regulations, we have capital
requirements, we have deposit insurance, we have access to the
Fed's discount window to make sure that payment processing
system works, and is liquid. And that is part of it, of the
banking system. That is a core piece. That is--unlike these
crazy derivatives and some of the other things that large banks
do that give a lot of us heartburn, this is a core function of
what they should be doing, so the fact that this--
Mr. Carney. If I may--I have limited time, so--but over the
last 20 to 25 years, all these institutions that I just talked
about have been migrating away from that into what they
consider--
Ms. Bair. Well--
Mr. Carney. --more convenient--
Ms. Bair. --this was facilitated by a regulatory change
made by the SEC in the mid-1980s that allowed a mutual fund to
basically act like a bank. And, it worked until it didn't.
There have been numerous experiences where the bank has been
broken, but through sponsor support, you don't see that. We
would have had massive problems in 2008 if it hadn't been for
government intervention.
Mr. Carney. But ``it worked until it didn't''--we have
talked about why it didn't. I was not here in the Congress at
that period of time when the prime fund broke the buck. But we
saw much bigger problems in the banking system. We have much
larger concerns--I do--
Ms. Bair. In the wholesale funding markets, yes. You didn't
have systemic--you didn't have deposit funds. We had a seize-up
in the wholesale funding markets.
AIG, Lehman Brothers, Merrill Lynch, Bear Stearns--we had a
few banks that had some problems. I don't want to suggest
otherwise, but those are not depository-taking institutions.
Mr. Carney. But your response to, if you want a strong
sector--which I conclude that you don't think is the best
thing--you ought to do it through some kind of capital reserve
or some kind of insurance, not through--
Ms. Bair. I think they should act like other mutual funds.
I--with the floating NAV, all the other mutual funds flow
through NAV. I think money funds--they are mutual funds. They
should flow through NAV.
It is the structure, not the funds themselves. You have
lots of good corporate citizens who are offering these funds.
But the inherent regulator structure is an unstable one. This
is the classic reform of undoing a bad regulation, which
would--is what we got in the mid-1980s, which developed--was
the foundation for developing a very, very large shadow banking
sector in the sense that--
Mr. Carney. So, what does the floating NAV address in your
view? That--
Ms. Bair. It tells people that your money is not protected
at a dollar. It is not a cash equivalent. There are assets
underneath it that float in value. And if you want to redeem,
they are going to have to sell those assets for you to get your
money back.
So, it is honesty in accounting. And it is also, at the
end, you eliminate the first mover advantage, if you have a
stable NAV, when the underlying assets are not worth that
dollar, the more sophisticated investors--in this case,
institutional investors in 2008--they will run. They will have
an affirmative obligation to run, because they can still get
out for a dollar, even though that fund is now worth only 97
cents. They lock in the losses. And less sophisticated people
are left behind. They are the ones ending up holding the bag.
It is a structural weakness that needs to be addressed.
Mr. Carney. I wish I had more time for a fuller discussion.
Thank you, Mr. Chairman.
Mr. Hurt. And, Mr. Carney, I think you will have that
opportunity.
This has been an excellent hearing. And we certainly
appreciate the indulgence of the panel. And if it suits your
schedule, we would love to have you stick around just for a few
more minutes. I think there are Members who would like to ask
additional questions, and we will limit those to 2 minutes, if
you all can--if you could bear with us.
And so, with that in mind, I will kick it to Mr. Stivers
for a period of 2 minutes.
Mr. Stivers. Thank you.
I really appreciate the indulgence of a quick second round.
I have two questions. One is for Mr. Stevens.
A lot of the panelists here seem to ignore the 2010 rule
changes that changed the investment criteria for money market
mutual funds, thus making them more stable.
Can you just spend maybe 30 seconds talking about why that
is important when you limit what they can invest in, and how
that keeps the stable net asset value a viable way to go?
Mr. Stevens. Thank you, Congressman.
What the rules did is impose a whole set of heightened
risk-limiting conditions on money market funds. And they were
almost immediately tested in 2011 during the crisis in the Euro
zone, and at the time of the debt ceiling controversy and the
downgrade by one of the ratings agencies of U.S. Government
securities.
We came through that fine in part because of the 2010
amendments.
Mr. Stivers. Thank you. I only have a little bit of time. I
also want to give Ms. Chandoha a chance.
I am kind of scratching my head with your position, because
it appears to me, your position is that a floating net asset
value is great, except where it affects you. You want--you like
the exemption on government funds, and you happen to have the
biggest government fund in the country. And you want a retail
exemption, and 99 percent of your customers are retail.
So, help me understand how you sort of put that together,
that you like a floating NAV, but not where it affects you. You
want the exemption.
Ms. Chandoha. Certainly, our clients are retail investors.
And, what we appreciate with the SEC's review is that they
focused in on where the potential risks lie in the money fund
industry.
We do believe that regulations should focus in on where the
risks lie, and not necessarily be a one-size-fits-all approach.
So, that does benefit us. But we do think that retail
investors did not run--they are very stable investors--and that
retail investors should be segregated from institutional
investors who do have the ability to run and move assets more
quickly.
Mr. Hurt. Thank you, Ms. Chandoha. Thank you--
Mr. Stivers. Thank you. And thank you, Mr. Chairman. I
yield back.
Mr. Hurt. Thank you.
The Chair now recognizes the ranking member of this
subcommittee, Mrs. Maloney, for 2 minutes.
Mrs. Maloney. Thank you.
I would like to ask Ms. Bair and Mr. Stevens--a lot of
cities, including mine, New York City, believe that they need
the money market funds in order to finance their day-to-day
operations. They depend on them. Do you believe a floating rate
would have hurt a city's ability to finance their local
projects and their local concerns?
And in the debate on the floating NAV, is that the only way
to eliminate the accounting or the cliff effect that you keep
talking about, Ms. Bair, or are there other ways to eliminate
it that wouldn't result in such a radical restructuring of the
money market industry?
Mr. Stevens and Ms. Bair?
Ms. Bair. So, as I said before, guarantees without capital
behind them make it cheaper for everybody to do business, but--
and especially with implicit government support, which I think
has been a factor in the money fund industry--that model works
until it doesn't. It doesn't work in times of distress.
If you don't want to go to a floating NAV, the next best
alternative, I think, is to require capital behind a guarantee.
If funds want to guarantee a dollar, even when the assets are
less than a dollar, then force them to have some capital behind
that. That is the approach being used in Europe.
I think the simpler, cleaner approach is a floating NAV.
And I think that you will still have funds that retain a high
degree of liquidity, that invest in short-term securities. They
will float slightly, but they will still float, reminding
people they are not guaranteed.
So, I don't think they are going to completely go away. But
if you don't want to do floating NAV, I think the best next
best option is capital, which is what the Europeans are doing,
basically--proposing.
Mr. Stevens. Very quickly, tax-exempt money market funds
provide about 70 percent of all short-term municipal finance in
the United States. If you create the characteristics in those
funds that investors are not interested in, that source of
finance will disappear. And it will have a significant effect
on State and local governments throughout the country.
Witness my colleague here from Georgia today, and the
thousands of others--State and local government officials--
whose point of view about this is very much in the SEC's
records.
Mr. Hurt. Thank you, Mr. Stevens.
The gentlelady's time has expired.
The Chair now recognizes the gentleman from Massachusetts,
Mr. Lynch, for 2 minutes.
Mr. Lynch. Thank you, Mr. Chairman.
And, again, thank you for all your help today. It has been
a very good hearing.
Hypothetically, if we did go to the floating NAV, it
requires a daily evaluation of the underlying assets. And while
we have a 10 percent requirement for--excuse me--we have a 24-
hour requirement that 10 percent be redeemable within 24 hours,
and then there is a--I think is a 30 percent over 7 days. You
still have a very large body of assets that are less liquid.
And I am just wondering, in the past, we have had very
difficult time marking-to-market some of these less liquid
assets. Does anybody have a suggestion that might allow us to
avoid using internal models that, in some cases, in the past--
especially during a crisis moment, we come up with these, let's
call them, generous valuations on the part of the asset holder
that we ran into back in 2008. Is there any way we can, sort
of, manage this within the floating NAV scenario?
Mr. Stevens. Congressman, I don't think we have problems
valuing these portfolios. The weighted average maturity of the
instruments in the portfolio is 60 days or less. You are
talking--
Mr. Lynch. That is the average, though.
Mr. Stevens. The--
Mr. Lynch. I am saying--
Mr. Stevens. --dollar-weighted average.
Mr. Lynch. --you are going to have. I am just asking how
confident can investors be that these assets have been valued
properly?
Mr. Stevens. I think, very highly confident. Our members
are putting out information, filing with the SEC, about what
the mark-to-market value of these portfolios is.
Mr. Lynch. But they are using their internal models. If
there is no turnover, or if there is not an active market in
that asset, we don't have a--we don't have a market valuation
available. So somebody has to approximate that.
And so, in the past, during a crisis period, we have had
some very wacky valuations that have not held up over time.
Mr. Stevens. Right.
Mr. Lynch. And I am just trying to anticipate how we would
avoid that.
Mr. Stevens. These are instruments that are valued
according to amortized cost. And as I said at the beginning of
the hearing, it's a valuation method the Chairman of FASB
talked about how it applies in the context of money market
funds. I think it produces a very reliable mark-to-market price
that deviates very, very little on a--
Mr. Lynch. Thank you, Mr. Stevens.
Mr. Stevens. --between the dollar value.
Mr. Hurt. Thank you.
Ms. Chandoha. I would just comment that we have been
producing shadow NAVs on our money funds. And we used outside
pricing services to price those.
Mr. Hurt. Thank you.
The Chair now recognizes the gentleman from Georgia, Mr.
Scott, for 2 minutes.
Mr. Scott. Yes, very quickly. One point we are missing in
the first round was on retail funds. And I would like to get a
response from Ms. Bair, Ms. Chandoha, and Mr. Stevens quickly.
The proposed rule defined a retail fund as one that allows
share holders to withdraw less than $1 million a day. And the
retail funds would be exempt from the floating net asset value
requirement in the rule.
Now, Charles Schwab has proposed that limit be raised to $5
million. And there have been others who have suggested that the
retail funds be limited to investors with a Social Security
number or a particular retirement plan. Can each of you just
very briefly give me a comment on that, on your definition of a
refund fund and what changes you might propose in that
definition and why?
Ms. Bair. I think, as I think they should all float. I
think is very--one of the problems with trying to describe
about retail, is very difficult to come up with a definition
that can't be gamed.
And I do worry, even with a $1 million redemption daily
limit, that is still a pretty big size redemption. And people
like my mother in Illinois who are not going to be checking
their balances everyday are going to be stuck where the people
who are more sophisticated are going to be able to get out
first with this first-mover advantage, which you have at the
Savynap.
So I think they should all float. But if you are going to
keep it to retail, make sure it is retail. And don't let a lot
of sophisticated money into this fund.
Mr. Scott. Ms. Chandoha, you are Charles Schwab, and you
recommended it, so?
Ms. Chandoha. Yes, we do think it makes sense to segregate
retail and institutional investors because institutional
investors can move more quickly. And your mother might be
impacted.
We do think that there are various ways of delineating
between retail and institutional investors. We made a
recommendation around the $5 million redemption limit. Social
Security numbers could be another method for doing that.
Mr. Scott. And, Mr. Stevens, you agree?
Mr. Stevens. You and I both, as individual investors, have
a Social Security number on every account. That's an easy,
administrable, and very clear line between investors like you
and me and a hedge fund.
Mr. Scott. Thank you, Mr. Stevens.
Mr. Stevens. Thanks.
Mr. Hurt. I thank the gentleman from Georgia.
I want to thank everybody on this panel for their
participation. I do think this was a very good hearing. And I
thank you, especially, for indulging us in a second round of
questions.
The Chair notes that some Members may have additional
questions for this panel, which they may wish to submit in
writing. Without objection, the hearing record will remain open
for 5 legislative days for Members to submit written questions
to these witnesses and to place their responses in the record.
Also, without objection, Members will have 5 legislative days
to submit extraneous materials to the Chair for inclusion in
the record.
Thank you. This hearing is now adjourned.
[Whereupon, at 12:28 p.m., the hearing was adjourned.]
A P P E N D I X
September 18, 2013
[GRAPHICS NOT AVAILABLE IN TIFF FORMAT]