Regulatory Expansion via “Too Big to Fail”

When we can, consumers save for a house, for retirement, for college, or for unexpected expenses.  Savings sometimes molder in bank accounts, but wise savers use a portfolio of certificates of deposit, mutual funds, common stocks and bonds.  

In the depths of the housing-finance recession, the federal government loaned billions to mortgage-lending banks they deemed “too big to fail.”  Government feared that defaults in mortgages could shatter bank balance sheets in ways that the Federal Deposit Insurance Corporation would need to repair.  In its “Dodd Frank” bill, Congress exploded Federal Reserve Board and Securities and Exchange Commission authorities over the financial sector.  Banks are being sheathed in heavy regulations such as restrictions on lines of business (so called Volker rule) and onerous equity to debt ratios constraining banks’ leverage.  Bank, insurance and stock market regulations are being written slowly.  Now mutual funds are being considered for “too big to fail” status.  It’s doubtful that consumers need government help with their mutual funds.

Mutual funds are poster children for massive scale.  Black Rock manages $3.8 trillion in assets, Pimco manages $2 trillion, and other fund families for a total of $53 trillion.  All financial assets — domestic, foreign, government, corporate, bonds and stocks — are organized into “funds.”  Investors can buy or sell fund shares as they chose.  Mutual funds fluctuate in value based on interest rates, world events, tax policy and corporate performance.  “Best in class” stock picks are available for higher fees than charged for bland index funds.  Fees vary from about 0.1% to 2% or more for funds with highly attractive yields or assets.

The primary issue concerning regulators seems to be market liquidity while adjusting a fund’s portfolio.  Funds of briskly traded stocks can adjust their holdings without materially changing the market price for the stock.  But funds holding sparsely traded stock will likely change the market price if they place large orders to buy or sell.  Changing a large position in a thinly traded stock may require several trading days.  This is well understood and mutual funds carefully calculate their scale limitations based on the stocks they will hold.  In a real financial crisis it likely makes no difference whether a fixed volume of assets is being dumped by mutual funds and individuals or dumped by individuals alone.  

Fund values increase and decrease in sync with bond and equity markets and there is no recent history supporting a need for new regulations.  Recent headlines-grabbing misbehaviors were not committed by mutual fund companies.  The use of inside information (SAC, Galleon Management), Ponzi  schemes (Madoff), and misapplication of client money (MF Global) lead back to hedge funds and even more importantly, the crimes were prosecuted under existing regulations.

Mutual funds have not been prone to misadventure and they do not compound market risk – rather they spread market risk for consumers and they deliver market yields.  Their prospectuses acquaint consumers with all of the risks likely and unlikely to befall the investments.  While Congress may have given regulators the option of regulating everything financial, we trust regulators will limit their interventions to those with proven need.  Let’s not regulate merely because we can.

Alan Daley is a retired businessman who lives in Florida and who writes for The American Consumer Institute Center for Citizen Research

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Comments

  1. DeWayne Williams says

    This is good information to know but as we have observed the U.S. Government, Wall Street, the Banking system and Big business will do what it wants to do. If they break a rule they come up with a reason to get around it. If they fail suddenly the are ‘too big to fail’. The Average American will not get that kind of help.

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