In 2008, Oxford University Press published the first history of mutual funds, THE RISE OF MUTUAL FUNDS: AN INSIDER’S VIEW, by Matthew P. Fink, former president of the Investment Company Institute. Oxford has just published a new paperback edition, updated to cover the 2008 financial crisis and its impact on mutual funds. The following is the Preface to the new edition.
“Remember, the inevitable ineffectiveness of regulation.” - Louis D. Brandeis
Since publication of the first edition of my book, “The Rise of Mutual Funds: An Insider’s View” (Oxford, October 2008), the financial world has been traumatized. House prices have fallen sharply, major banks, securities firms, and insurance companies have failed or been rescued by government, unemployment has soared, and the stock market has plummeted (though it subsequently rallied).
The economic crisis, the worst since the Great Depression, had its origins in a record run up in home prices, followed by the bursting of the housing bubble. I did not say a word about home prices in the first edition. Had I considered the matter, I might have predicted that home prices were due for a fall. But I never would have guessed that the decline would devastate the financial system and the economy as a whole.
During the years leading to the crisis, I did express concern that regulators were not keeping up with developments. I led the mutual fund industry in calling for regulation of asset-backed pools, hedge funds, and rating agencies. Not only did these suggestions fall on deaf ears, but policymakers moved in the opposite direction, jettisoning some controls (e.g., the SEC’s exemption of asset-backed pools from regulation), weakening others (e.g., the SEC’s lessening of capital requirements for broker-dealers), and declining to apply others (most famously, the Federal Reserve Board’s refusal to raise interest rates as the housing bubble grew). Actions and non-actions by regulators produced the economic crisis.
The story of the 2008 meltdown was not the failure of financial laws, but rather the failure of regulators to properly apply those laws.
Fortunately, during the good years of the 1980s and 90s, the mutual fund industry resisted the siren song of deregulation. Basic mutual fund controls such as required diversification, strict limits on borrowing, and mandated daily marking to market were not eliminated or weakened.
Therefore, while the 2008 storm hit mutual funds hard, they were not nearly as shaken as institutions that had never been regulated (hedge funds) or that had been deregulated (banks and securities firms). In this new edition I discuss the impact of the 2008 meltdown on mutual funds generally, as well as specific areas such as money market funds, the fate of the SEC, and 401(k) plans.
Looking ahead, I have relatively few worries about the mutual fund industry. The industry and its regulator, the SEC, still seem intent on retaining and strengthening core controls (see the SEC’s recent caveat on leverage via derivatives), while modernizing fund regulation (such as recent prospectus reform).
I am far more concerned about regulation of the financial system generally. The 2008 crisis was followed by a national debate over financial reform. There were those in the academia, in the media, in Congress, in the Obama Administration, and even in the financial industry who called for fundamental reform that would impose strict statutory limits on the activities and size of financial institutions, so that none would be “too big to fail.” But the administration and Congress rejected this advice.
Instead, they opted for a massive 2,319 page law that grants regulators, who had helped produce the crisis, even more authority. The Dodd-Frank Act provides the SEC and the Federal Reserve Board with greatly expanded powers and creates entirely new regulatory bodies such as the Consumer Financial Protection Bureau and the Financial Stability Oversight Council.
I hope that this reliance on regulation works. Experience indicates that it won’t.
I fear that we are headed toward a world of giant financial conglomerates that are impossible to manage or to regulate, riddled with conflicts, and periodically in need of massive government bailouts.
Matt Fink can be reached at email@example.com.