Treasury Secretary Timothy F. Geithner put pressure on the U.S. Securities and Exchange Commission to tighten oversight of the $2.6 trillion money- market fund industry, saying the funds may pose a risk to the stability of the financial system.

The Financial Stability Oversight Council, a group of regulators that includes the SEC and is headed by the Treasury, should release for public comment options for an overhaul of the funds, an alternative to bank accounts for individuals and companies, Geithner said in a letter to the council today.

“Without further reform of MMFs, our financial system will remain vulnerable to runs and instability,” Geithner said. He said he wants the council to consider the recommendations at its November meeting.

SEC Chairman Mary Schapiro last month gave up on a plan to tighten regulation of the funds after three of the five commissioners -- Republicans Daniel Gallagher and Troy Paredes, joined by Democrat Luis Aguilar -- told her they wouldn’t vote to issue it for public comment.

Geithner’s letter “significantly increases the political pressure for the SEC to take another look at this,” said Joseph Engelhard, senior vice president of Washington-based investment advisory firm Capital Alpha Partners LLC.

The SEC “is best positioned to implement reforms to address the risks that MMFs present to the economy,” Geithner wrote. Even so, he said, the council and its members should “take active steps in the event the SEC is unwilling to act in a timely and effective manner.”

Dodd-Frank Act

Geithner said the council should use its authority under the Dodd-Frank law to designate the activities of money-market funds as systemic, which would act as a formal recommendation to the SEC to act. Geithner said FSOC also has authority to designate individual firms or to label them as payment, clearing and settlement activities, which would put them under heightened supervision.

Schapiro said in an opinion piece in the Wall Street Journal last week that the FSOC is the “right organization to tackle this issue.”

Geithner today recommended considering three steps to reduce the risk funds might pose to the financial system: floating net asset values, requiring funds to hold capital buffers of “adequate size,” likely less than 1 percent, and imposing capital and enhanced liquidity standards.

Financial Crisis

The SEC, along with the Federal Reserve and the Treasury, has pressed to make money funds safer since the September 2008 collapse of the $62.5 billion Reserve Primary Fund, which triggered an industrywide run and helped freeze credit markets. The crisis calmed only after the Treasury temporarily guaranteed shareholders against losses and the Fed began buying fund assets at face value to help them meet redemptions.

“The chairman has long believed that addressing the susceptibility of money market funds to destabilizing runs is a critical piece of unfinished business from the financial crisis,” SEC spokesman John Nester said today in a statement. “That is why she has advocated for reforms to bolster the structure of these funds. She is very pleased that this important reform initiative is moving forward.”

The SEC’s Gallagher, in an interview earlier today, said he would support a measure forcing the industry to abandon its marquee $1 share price. Requiring funds to have a fluctuating share price “is an attractive option that I am likely to support,” he said.

Extra Capital

Gallagher said he couldn’t vote for Schapiro’s plan because its centerpiece was to make the funds hold extra capital. The proposed cushion was too small to protect investors, Gallagher said.

Schapiro has argued that the funds’ $1 share price encourages investors to flee at the first sign of trouble. That’s because those who react quickly can sell their shares at $1 each even if the net asset value has dropped below that level.

The industry has maintained that a floating share price would make money funds unworkable for many investors by saddling them with new accounting and tax obligations. In addition, insurers, municipalities and other large users of money funds are often legally bound to invest assets they account for as cash in funds with a stable share price.

The FSOC meets in a closed session tomorrow. The council may also vote to request confidential data from non-bank financial companies that might later be branded as systemically important, two people with knowledge of the plans said this month. Companies designated by the FSOC would be subject to Federal Reserve supervision.

Bailed-out insurer American International Group Inc. has said it meets thresholds the council set to decide which firms require further evaluation. GE Capital, a unit of General Electric Co., has said it expects to be named systemically important.

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