A long list of federal government failures — among them the disastrous rollout of the websites for the private exchanges created by health-care reform; public health system confusion and inconsistency over the Ebola outbreak; Secret Service misconduct and failures; Veterans Administration inefficiency; the administration's indecision in the war on terror — have created a crisis of confidence in traditional sources of strength, trust and leadership.
Asset owners, institutional investment management firms and the markets are not immune from crises of confidence.
The financial crisis of 2008 created a breakdown in confidence in institutional investment management, the markets and regulators. The investment losses that followed raised the concern as to whether regulators were capable of carrying out their responsibilities.
However, the crisis produced a number of expensive lessons for institutional investors. One takeaway from the excesses of the markets is that institutional investors should focus on objectives, strengthen risk management, and avoid distractions that cloud priorities.
Asset owners, other institutional investors and regulators also need to guard against overreaching to correct flaws and failures.
Regulators certainly are in danger of overreaching. For example, in its efforts to reduce potential threats to the stability of the financial system, the Office of Financial Research has included the investment management industry as a focus of its studies of areas of risk. The OFR study could serve as potential grounds for further regulation of money managers by labeling major firms “systemically important financial institutions.”
That label would mean their failure risks causing a systemwide breakdown of the market and economy. It also would subject them to bank-type regulation under Federal Reserve oversight, in addition to existing SEC oversight. But the OFR — created by the Dodd-Frank Wall Street Reform and Consumer Protection Act and housed within the Department of the Treasury to bolster the research for policymakers — certainly overreached in its analysis.
Investment management firms did not cause the financial market crisis. In fact, the OFR's study went off course trying to make a connection between the stability of the markets and the risk to the stability of money management firms stemming from the types of investments they make.
In the greatest financial crisis since 1929, no mainline institutional money managers were brought down by their investment portfolios, nor were their clients. Any new regulations imposed on money management firms would not reduce the risks to the financial system and, in fact, would distract regulatory attention from areas in need of greater oversight.
Focusing attention on major money management firms as potential risks to the stability of the market leaves the Fed exposed to squandering resources it could better use to identify more likely sources of systemic risks. That would actually increase the risk of a systemic breakdown in times of market instability, creating a crisis in confidence in the ability to oversee the financial system.
In another example of overreaction, the Securities and Exchange Commission, by taking on additional oversight duties, risks diluting its strengths from its primary responsibilities that include ensuring fair markets and protecting investors.
Daniel M. Gallagher, SEC commissioner, raised such concerns in an Oct. 16 in a speech at Fordham University Law School. Legislative mandates risk diverting the SEC from “the best use of the commission's time and resources,” he said.
For example, he cited “sociopolitical issues,” such as conflict minerals or natural resources extracted in conflict zones and used to finance further fighting, or other financial issues, such as swaps regulation that “has taken up a wildly disproportionate amount of the commission's attention.”
The SEC should not take on regulatory concerns that have a remote connection to investing, as Mr. Gallagher suggested. Congress should direct issues worthy of critical attention to agencies better equipped to deal with them. Otherwise it risks diluting SEC resources from its fundamental priorities, thus putting investors and markets at more risk.
The “last thing the SEC needs is more "turf' ” and “the very real risk of overextension,” losing focus from the core of its mission, Mr. Gallagher said.
Congress has legislated many of these new responsibilities to the SEC. Commissioners like Mr. Gallagher can push back, but asset owners and other institutional investors also need to speak up to ensure regulators keep focused on priorities. After all, investors are most exposed in terms of additional costs imposed from misdirected regulatory oversight and to risks of losses from market failures.
In addressing systemic risk to the markets, Mr. Gallagher noted the best way the SEC can contribute is by fulfilling its “mandate to maintain fair, orderly and efficient markets, facilitate capital formation and protect investors.”
Avoiding crisis in confidence in institutions often is a matter of identifying the sources of distraction from priorities. Asset owners and other institutional investors need to step up and express concerns to Congress and other policymakers, urging them not to let the SEC dilute its focus and its ability to contribute to confidence in the markets.