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How Reform Dies in Washington

David Callahan

One of the scariest moments of the 2008 financial crisis was the run on money market funds. It was a moment when, suddenly, many regular investors feared that their own cash could disappear into thin air -- along with the billions going poof at big firms like Lehman Brothers and Merrill Lynch.

The federal government stepped in to quell the panic and, in the wake of the crisis, money market funds were an obvious target for reform. New rules were enacted in 2010, but were seen as temporary until bigger reforms could be put in place. The stakes could hardly be higher: If another panic hits, experts say that money market funds -- which many investors treat as a safe haven -- could unravel and perhaps bring down the entire financial system.

Last week, though, SEC Chairman Mary Shapiro withdrew a major proposal for reform after being blocked by other SEC commissioners. Or, rather, one commissioner: Luis A. Aguilar. Today, the New York Times has a disturbing story about Aguilar's role in blocking Shapiro.

Anguilar, who worked as a lawyer for the mutual fund industry for eight years, said that he believed the impact of reforms needed to be studied more. This stance seemed overly cautious, given the urgency of reform and the fact that regulators have been studying this issue intensively for over a year. Now comes the revelation that Anguilar didn't ask for more analysis when he had the chance. As the Times reports:

. . . Mr. Aguilar has been adamant that he is not against prudent reform. He has said instead that he wants to be sure regulators have enough information before they move forward with new rules.

Behind the scenes, though, Mr. Aguilar had not requested that additional information, according to people briefed on his actions in recent months.

In his statement outlining his opposition to Ms. Schapiro’s plan, for instance, he said “there are larger macro questions and concerns about the cash management industry as a whole” that needed to be studied before the S.E.C. could move forward with efforts to improve money market funds. Mr. Aguilar did not mention the need for further study to Ms. Schapiro until two days before he went public with his opposition last week, commission officials said.

Possible changes to money market funds have been discussed within the agency for over a year, and Ms. Schapiro distributed the 414-page proposal in June to the four other members of the commission, including Mr. Aguilar. During that time, S.E.C. staff members made numerous overtures to Mr. Aguilar to address any concerns he might have had about the proposal, but most were rebuffed, the people said. On the other hand, Mr. Aguilar met with mutual fund companies 11 times this year as the proposal was being developed, according to S.E.C. records.

Shapiro's proposal was, by all accounts, not some radical plan. She had the backing of both Treasury Secretary Tim Geithner and Fed Chairman Ben Bernanke. She also had the backing of two Democratic commisioners of the SEC and should have had the backing of Aguilar, normally a supporter of reform. But it appears that the industry got to him.

One of the industry’s primary arguments was that the 2010 rule changes had done enough to make money funds safe. While Mr. Aguilar did not say this was the case, he said last week that the agency needed to study the effect of the 2010 measures before making other changes.

According to the people briefed on his actions at the time, there was a lengthy section on the effect of the 2010 changes in the June proposal, but they said Mr. Aguilar never asked for more study.

The moral of the story here is how easily reforms can die in Washington, even in regulatory agencies ostensibly controlled by officials who believe in regulation. We have seen this again and again. Last month, for example, it was another regulator you've never heard of -- Edward J. DeMarco, the acting director of the Federal Housing Finance Agency -- who nixed an important reform, shooting down the idea of writing down principal on mortgages.

Washington is hostile territory for real reformers. Replacing turncoat regulators should be a top priority if President Obama wins reelection.