April 24, 2012

By Beagan Wilcox Volz

Boston Fed president Eric Rosengren’s recent remarks on the need for further money market fund reforms have drawn fire from an industry supporter.

Melanie Fein, a former Fed attorney now in private practice, disputes Rosengren’s contentions in a recent speech that prime money funds are susceptible to runs and are a source of systemic risk. Fein says in a 21-page letter to Rosengren dated April 18 that she has been “greatly troubled” by Fed officials’ statements that she believes “distort the facts” about money funds and their role in the financial system.

“In particular, I am concerned about proposals advocated by yourself and other Fed officials that do not appear to be supported by the level of economic analysis that is called for given what is at stake…,” writes Fein. “Some of the proposals and public statements seem disingenuous and have an amateurish ‘shooting from the hip’ quality that I feel is beneath the dignity of the nation’s central bank.”

Joan Ohlbaum Swirsky, of counsel at Stradley Ronon, says the comments about insufficient economic analysis are “fighting words,” given that the Securities and Exchange Commission has lost several legal challenges on the issue of cost-benefit analysis, most recently with its rule that sought to expand proxy access.

In her letter, Fein takes several of Rosengren’s contentions and parses them, pointing to what she says are gaps in logic or insufficient facts to warrant his conclusions. Fein also sent the letter to the Financial Stability Oversight Council and the SEC, which filed it as a comment letter.

For example, Fein calls attention to Rosengren’s comments regarding more than 100 capital support agreements between money funds and their sponsors during 2007 and 2008 and his conjecture that, in the absence of this support, many of the funds would not have been able to maintain a stable net asset value. This led Rosengren to conclude that regulators should impose a capital requirement or other structural changes on money funds, Fein says.

But the facts don’t support this conclusion, Fein asserts, noting that bank-affiliated sponsors of money market funds provided the majority of these bailouts. She also refers to a Federal Reserve paper that found that money funds with bank-affiliated sponsors were “significantly” more likely to hold distressed asset-backed commercial paper than other money funds. The Fed paper said that these support arrangements for bank-affiliated money funds created moral hazard and systemic risk.

“The history of sponsor support for [money market funds] suggests not that MMFs need to maintain capital but rather that banking organizations that provide support to their affiliated MMFs need to maintain capital and that the Federal Reserve should refocus its concerns about MMF risk-taking to risk-taking by bank-affiliated MMFs,” writes Fein.

Fein goes a step further and says that perhaps the Fed should first consider changes to rules within its own jurisdiction rather than suggesting changes to rules within the SEC’s regulatory scope.

John Hunt, partner at McLaughlin & Hunt, says that Fein turns Rosengren’s statements about the risks of prime money funds on their head by arguing that it’s likely there are more risks in bank-affiliated money funds “because the banks are on both sides – they’re both buyers and sellers of money market fund instruments.”

Fein is challenging Rosengren and the Fed to back up the “bald statements” made about money market funds, he says.

Fein’s letter quotes at length from the President’s Working Group Report on Money Market Fund Reform to bolster her argument that making money funds risk-free “is not a sound policy aim.” Fein includes several sentences from the report in bold, including this one: “Making each individual MMF robust enough to survive a crisis of the size of that experienced in 2008 may not be an appropriate policy objective because it would unduly limit risk-taking.”

Fein also draws upon the President’s Working Group report when making the case that neither reform being considered by the SEC – a floating NAV or capital buffers, along with redemptions restrictions – is a good idea.

She says that experience shows capital requirements are a “weak guard” against taking risk. “The bank capital rules actually encouraged excessive risk-taking by banks and contributed to the build-up of toxic assets in the financial system that ultimately caused the financial crisis, as pointed out in my paper. The idea that MMFs should maintain capital is not supported by any economic analysis that I am aware of,” she says.

At the beginning of her letter, Fein refers Rosengren to a study she conducted that dissects Fed statements on money funds and concludes that the Fed is pushing for additional reforms of the funds to bolster the banking industry. She also notes that she has represented both money fund and bank clients.

Fein has previously written comment letters on SEC-proposed regulations on behalf of Federated Investors.

At the end of the letter, Fein tells Rosengren that, although she has been critical of his statements and proposals regarding money funds, she hopes he will not take her comments personally or as an attack on the Fed. She adds that she believes the Fed acted admirably during the financial crisis.

“I firmly believe, however, that it is unnecessary and potentially dangerous for the Fed to become involved in regulating an industry with which it has little regulatory experience or expertise, especially one that is well-regulated by another independent federal agency and that historically has operated with little risk to investors or the financial system,” writes Fein.

Media relations contacts at the Boston Fed did not respond to requests for comment by deadline.