WSJ, Editorial Pages
Treasury moves to regulate asset managers as ‘systemic risks.’
After JP Morgan CEO Jamie Dimon warned that regulation under the Dodd-Frank law was going too far, Washington retaliated with investigations leading to a record $13 billion settlement. But how will Team Obama react now that one of the law’s principal authors is questioning the regulatory expansion?
Retired House Democrat Barney Frank is the last person on the planet you’d expect to criticize implementation of the 2010 law that bears his name. But there he was at a recent event hosted by the Clearing House trade group, suggesting that regulators ought to focus on banks instead of mutual-fund companies.
According to the Clearing House, Mr. Frank said he did not favor designating such large asset managers as BlackRock or Fidelity as “systemically important” and that this was not the intent of his law. He added that “overloading the circuits isn’t a good idea” and said that the Financial Stability Oversight Council created by Dodd-Frank “has enough to do regulating the institutions that are clearly meant to be covered—the large banks.” Mr. Frank told the crowd, “I have not seen the argument made yet to cover” the “very plain-vanilla asset managers.”
We haven’t either. An asset manager decides where to invest money on behalf of clients. The profits or losses on these investments accrue to the clients, not the manager. A market decline shouldn’t threaten an asset manager or the larger financial system. This is different from a bank, which loans the money it collects from depositors, who expect to be able to withdraw every penny they entrust to the bank. Taxpayers are on the hook to make sure promises are kept on insured bank deposits.
In contrast to risk-averse bank depositors, customers who use asset managers to help them invest in stocks or bonds generally understand that it’s their problem if the investments decline in value. And investors’ willingness to take such risks provides essential capital to grow businesses and the economy.
Money-market mutual funds with their implicit federal backstop (made explicit in 2008) are an unhealthy exception to this bright line between banking and investing. But the answer in that case is to reform money-fund rules to clarify that such shares can lose value, not to apply bank regulation across an industry of non-banks.
The first hint that Treasury wants to regulate non-banks came in a September report from its Office of Financial Research. Requested by the stability council, the report described how asset managers could be vulnerable to “financial shocks” and threaten the financial system. The report is widely interpreted as step one in deeming the largest asset managers as too-big-to-fail. For investors this means heavy regulatory costs that will find their way into higher fees. For taxpayers, it means the potential for more bailouts.
The stability council was supposed to coordinate action among the various Washington regulators overseeing parts of the financial system. But this case seems to confirm fears that the council will largely be run by bank regulators, and especially by the Treasury Secretary, who chairs the council. Current Treasury chief Jack Lew knows about too-big-to-fail banks, having been present during the disastrous mortgage bets at Citigroup C +0.10% that triggered a series of bailouts. But it’s not clear that he understands the difference between banks and non-banks. His council has already slapped the systemic tag on two large insurers, Prudential and AIG.
The Treasury report does acknowledge that in contrast to banks making loans with depositors’ money, asset managers simply act as agents for their investors. But the report then highlights problems that can happen regardless of whether one invests via an asset manager—for example, by “reaching for yield” or “herding” into a popular asset.
Yes, piling into the year’s hottest investment can end in tears. But without the freedom to make such mistakes, investors and asset managers cannot fund the ideas and innovations that create wealth and jobs.
And however one invests, a lousy return doesn’t trigger a crisis. During the dot-com boom, investors loaded up on technology shares directly and via mutual funds. But even a decline of more than 60% in the Nasdaq didn’t spark a financial crisis, because investors were generally playing with their own money, not funds raised from depositors. Has anyone at Treasury studied the asset management business, or at least consulted the Securities and Exchange Commission?
Nancy Pelosi famously said that Congress had to pass ObamaCare to “find out what’s in it.” Americans now must learn from the regulators what’s in Dodd-Frank. The 2008 crisis taught us how poorly regulators control the risks of banking. Trying to remove risks from the world of investing—where these risks belong—could do great harm.