Federal Reserve Governor Daniel Tarullo joined a call for the Securities and Exchange Commission to tighten oversight of the $2.5 trillion money market fund industry, which he said puts financial market stability at risk.
“Money market funds remain a major part of the shadow banking system and a key potential systemic risk even in the post-crisis financial environment,” Tarullo said in a speech today at the University of Pennsylvania Law School in Philadelphia.
SEC Chairman Mary Schapiro in August gave up on a plan to tighten regulation of the funds, an alternative to bank accounts for individuals and companies, after three of the five commissioners told her they wouldn’t vote to issue it for public comment. Treasury Secretary Timothy F. Geithner urged “further reform” of money market funds in a letter last month to the Financial Stability Oversight Council, a group of regulators that includes the SEC and is headed by the Treasury.
Alternatives to tighter money fund regulation by the SEC, such as having the FSOC designate the funds as systemically important, or having other regulatory agencies curb the institutions’ ability to borrow from or invest in money funds without structural protections, are “decidedly a second-best alternative” to SEC action, Tarullo said.
“The protective tools available to the rest of us do not fit the problem precisely and thus will not regulate at the least cost to the funds while still mitigating financial risk,” Tarullo said. “My hope, of course, is that recent indications that other SEC commissioners are now willing to move forward with reforms will lead to the SEC adopting first-best measures in the near-term.”
Lawmakers should weigh capping the size of the largest financial institutions, because U.S. law permits the biggest banks to grow large enough that they increase “perceptions of at least some residual too-big-to-fail quality,” Tarullo told students and faculty.
“There is, then, a case to be made for specifying an upper bound,” he said. “With the potentially important consequences of such an upper bound and of the need to balance different interests and social goals, it would be most appropriate for Congress to legislate on the subject.”
The idea “that seems to have the most promise would limit the non-deposit liabilities of financial firms to a specified percentage of U.S. gross domestic product,” Tarullo said.
Tarullo, 59, has led the Fed’s effort to implement the Dodd-Frank Act, the biggest overhaul of financial regulation since the 1930s, and pushed to raise capital standards for the largest banks, subject them to annual stress tests and boost scrutiny of their lending and trading practices.
Tarullo previously was a professor at the Georgetown University Law Center in Washington and an aide to President Bill Clinton. He was nominated by President Barack Obama and has served on the Fed board since January 2009.