A top federal regulator’s effort to reform money market funds - reform them into uselessness, that is - is dead. But don’t celebrate yet; this bureaucratic monster may still try to rise from its crypt.
For four decades, money funds have served investors well as a place to park cash that they might need on short notice, usually at somewhat higher interest rates than are available at a federally insured bank. The funds are not insured, and their value is not guaranteed, though their share price is held constant at $1 per share by design. Only twice has a fund “broken the buck” by allowing its shares to fall below $1. (Shares will never rise above that value, because the funds can simply issue new shares.)
Securities and Exchange Commission Chairman Mary Schapiro wants to change all that. She has backed a rule that would force money market funds to allow their share prices to fluctuate. The fluctuations would be tiny, and would cause fund investors a major bookkeeping headache as they tracked and reported gains and losses for tax purposes. But somehow these small fluctuations will supposedly remind investors that the money funds are not backed by the federal government. And this reminder is supposed to prevent future panic.
Even worse, Schapiro’s proposal would require funds to hold back some of an investor’s money when the investor wants to make a big withdrawal. The idea is that if a fund’s share price is at risk of declining, investors should not be able to avoid the loss by selling beforehand. Imagine if we applied that rule to the entire stock market.
I have previously written about the damage Schapiro’s proposal would do to the funds, and my voice was just one among many. Widespread opposition did not deter the SEC chief from scheduling a vote on her new rules.
But something unexpected, or at least unexpected by Schapiro, happened. In late August, Schapiro was forced to cancel the five-member SEC's vote, because she was going to lose. Commissioner Luis Aguilar - like Schapiro, a Democratic appointee - had decided to join the SEC’s two Republicans in opposition, according to The Wall Street Journal. Aguilar called for further study to determine whether money market funds, whose regulation has already been tightened after a large fund broke the buck during the 2008 financial crisis, require any further steps.
That’s great news, but not great enough. The Federal Reserve shares Schapiro’s misplaced perception of money funds as a source, rather than a victim, of the 2008 troubles. The Fed continues to focus on possible constraints in order to clamp down on money market funds’ utility, as well as their perceived risks for investors.
There are steps the Fed could take that would be reasonable, if not necessarily useful. The central bank is, after all, responsible for the health of the U.S. banking system. American and foreign banks have historically raised a lot of money from money market funds. This makes the funds a potential route to carry foreign (read: European) banking problems into the U.S. banking system, though the money funds themselves have already pulled back substantially from buying paper issued by foreign banks. The Fed may decide to restrict American banks from raising money from the money funds, which is its prerogative.
Of course, the Fed has already taken upon itself the task of providing banks virtually all the money they want at virtually no cost, which is why neither you and I nor money market funds can generate much income by lending money to U.S. banks today.
The bigger problem would result from more overt Fed regulation of the money market funds, should it conclude that the funds represent a systemic risk to the national or international global machinery. The funds, incidentally, pose no such risk. Schapiro and Federal Reserve Chairman Ben Bernanke are misreading what happened in 2008.
Money market funds did not cause the financial panic of 2008. They were not even part of the cause. Federal officials had to step in after the failure of the Reserve Primary Fund with a temporary backstop of other funds (doing so ultimately cost the government nothing, because no other fund broke the buck) only because the entire financial system was on the verge of collapse following the failure of Lehman Brothers. Money funds had nothing to do with Lehman Brothers’ collapse, except that the Reserve Primary Fund became a victim of it.
In September 2008, after Lehman collapsed, nobody knew which financial institution was safe - with the exception of the U.S. government, which can print all the dollars it needs. Money funds did not face a crisis of solvency or of liquidity; they faced a crisis of confidence that grew directly out of how the government regulated other institutions, not the funds themselves. Only the government had the ability to restore confidence, which it did, to our collective relief. Now, instead of recognizing their success and avoiding a recurrence of the underlying problems, wrongheaded regulators want to put investors on notice that in any future crisis of confidence, they should have no confidence.
This is not a smart plan.
The SEC majority may have killed Schapiro’s ill-thought-out proposal, but that’s not enough. We need other regulators to put a stake through its heart by acknowledging that money market funds are not the scapegoat they have been seeking for the failures of 2008.