Too big to fail; the catchphrase is about as hackneyed and trite as “where’s the beef?” and “show me the money, but here it comes again. Regulators are now considering provision that would deem that large mutual funds pose a systemic risk, which would then make them subject to the same reserve requirements as large banks. This could mean a serious hit to performance, and by extension, the account balances of average 401(k) investors.
Vanguard CEO 2008–2017
In an open letter to mutual-fund investors in a Wall Street Journal op-ed on Wednesday, a very unhappy Bill McNabb, chairman and CEO of the Vanguard Group, broke it down.
“Under the 2010 Dodd-Frank Act, all banks with more than $50 billion in assets are designated as systemically important financial institutions (SIFIs),” he explained. “If one fails, all other SIFIs will be responsible for bailing it out. The U.S. Financial Stability Oversight Council and the global Financial Stability Board are considering measures to designate mutual funds as SIFIs, which would impose the same bailout obligations on their investors.”
If that happens, McNabb warns, the 90 million Americans invested in mutual funds for retirement, education or a new home could be forced to once again bail out “too big to fail” Wall Street firms.
“Investor returns would suffer even absent a bailout,” he argues. “Mutual fund companies could be required to hold capital reserves, potentially up to 8% of the fund’s assets based on current Dodd-Frank requirements.
Such capital requirements would be raised through fees paid by investors. Any capital reserves that are sitting in a mutual fund are not generating returns in the stock or bond markets. According to research from the American Action Forum, capital requirements could trim as much as 25% from a mutual-fund investor’s returns over a lifetime of investing.
“Not only would investors pay more and get less, their funds would be investing in a weaker market. Today, investors benefit from a U.S. economy that features a stable banking system and vibrant capital markets. If regulators impose burdensome regulations on mutual funds, it could disrupt the capital markets and hamstring the formation of capital that fuels our economy.”
Mutual funds, he adds, are not banks. They do not impose risks on financial markets like banks do. They have fundamentally different structures with fundamentally different risk profiles. They are organized and regulated in a way that limits risk to the financial system. Designating a handful of mutual funds as SIFIs will not reduce systemic risk in the markets.
“Funds and their investors have stood the test of decades of market and economic cycles,” McNabb concludes. “They have provided a stable and diversified source of capital to the economy, and a low-cost, prudent way for individuals to invest for the future. Let’s not regulate for regulation’s sake. And let’s not go back to the misguided approach of having Main Street bail out Wall Street.”
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