Highlights
America has long enjoyed a global reputation as an opportunity society. The U.S. economy delivers the highest standard of living to its citizens. Among the more underappreciated aspects of U.S. prosperity is the opportunity for wealth creation, and how building wealth through investments has gotten easier and more affordable for Americans over the last few decades. However, threats to this progress persist, increasingly from federal regulatory agencies, for whom as the saying goes, “everything looks like a nail when you’re a hammer.”
The Federal Deposit Insurance Commission (FDIC) has embarked on a new regulatory effort to impose additional oversight in investment funds’ purchases of shares in U.S. banks. At present, the FDIC and the Federal Reserve Board (FRB) have somewhat overlapping authorities to review transactions in which investment funds take significant positions in banks. Currently, when the FRB reviews such transactions, the investment funds are exempt from filing a duplicative notice for review by the FDIC. Among other changes, the FDIC is proposing to eliminate this exemption.
Today, more than half of U.S. households are invested in mutual funds, which allow them to invest in a portfolio of assets specific to the fund, without having to invest in those assets individually. In many instances these funds simply map against an index, such as the S&P 500. These index funds tend to be low-cost as they don’t require the same servicing as actively managed funds. Exchange-traded funds (ETFs) are also popular with retail investors and share many similar characteristics as mutual funds. Like mutual funds, they can be structured to replicate market indices.
Over time, as investment has flowed into long-term investment funds, index funds have exploded in popularity. In 2010, total assets in all long-term funds stood at $9.9 trillion. Of this, 19 percent was invested in index funds. In 2023, total assets in long-term funds stood at $27.6 trillion, of which 48 percent was invested in index funds.
Along the way, the cost of investing has gotten dramatically cheaper. Since 2000, expense ratios for mutual funds have been cut in half, falling from 0.99 percent to 0.42 percent on an asset-weighted basis. Part of this dynamic is driven by the popularity of low-cost mutual funds. In 2000, 46 percent of mutual funds sales were no-load funds. In 2023, that figure stood at fully 92 percent. The growth of index funds has been essential to this trend, as equity index funds on average had an expense ratio of 0.05 percent compared to 0.65 percent for actively managed funds.
The upshot is that index funds offer households affordable opportunities to invest in stable, long-term products and build wealth over time. The system is working. One wonders, then, why a regulator would seek to potentially disrupt this market. One concern is that the proposal would allow the FDIC up to six months to review certain transactions. This inherently introduces needless bureaucratic friction to the operation of index funds.
Another major concern the FDIC has noted is index fund managers ability to exert “undue control” over banks they invest in. But Vanguard already has a passivity agreement with the FDIC. And recently, in a letter to the FDIC, BlackRock noted that they “almost always” side with bank management teams and “does not use engagement as a tool to manage or control a company.” In fact, of the banks that BlackRock had over 10 percent positions in, 99.85 percent of the time they voted with management on proxy items.
It’s also worth noting that this proposal was advanced in a party-line vote. FDIC board member Jonathan McKernan, who has expressed support for increasing scrutiny on these transactions, ultimately voted against the proposal because it is not coordinated with the FRB. Indeed, he expressed concern with an increased “undue regulatory burden” and duplicative regulatory notices, which would result from this rule.
This is another example of federal regulators proposing solutions in search of problems. The Biden administration has pursued a regulatory agenda of truly unprecedented scale, finalizing over $1.6 trillion in regulatory costs in less than a full term. This is nearly double the Obama administration’s $890 billion tally over two terms. It is unclear what identifiable harm this regulatory gambit from the FDIC seeks to prevent, but its potential impact on American families’ investment options is real. Given the agency’s recent challenges, it might serve them best if it stuck to its core mission without creating new opportunities to expand its reach.