photo by Eric Salard
The Securities and Exchange Commission’s new rules for making money market funds safer and more transparent for big investors became official on Friday, but they have been having an effect all year. Not a very good effect, though.
The funds’ customers have been abandoning them in droves.
Anyone with a fundamental understanding of how businesses used money market funds could have told you this would happen, and many of us did. This is a case in which being right does not bring much satisfaction, however.
As I observed in 2014, the final rules were less destructive than some of the original changes that the SEC proposed. But “less destructive” is still destructive. While individual investors were spared many potential headaches, institutional and corporate investors had little choice but to stock up on aspirin and start making new plans to manage their cash.
Consider Simon Gore, the treasurer of Spirit Airlines Inc., who spoke to The Wall Street Journal about the way the new rules complicated what was once a relatively simple job. Like many mid- or large-sized companies, Spirit had long parked its cash in money market funds as a way to protect principal and ensure the airline could meet its immediate cash needs. These funds offered a stable price of $1 per share. While they offered only small returns, they also offered stability and simplicity.
The new rules have put an end to both stability and simplicity. Instead, prime money market funds serving nonconsumer clients must allow net asset values to fluctuate, which creates both the possibility of assets losing value and the certainty of recordkeeping headaches. Gore and people like him must suddenly keep track of changes in their accounts’ value, the way they would in a traditional bond fund.
Just as we critics predicted, companies are pulling their assets out of prime money market funds. According to the Journal, assets under management at those funds have fallen by two-thirds this year, to $413 billion from $1.25 trillion at the beginning of 2016.
Corporate treasurers are still, by and large, working out where to put these funds now that money market funds have lost the characteristics that once made them so appealing. Gore said he has shifted much of Spirit’s cash to money funds that invest in government debt, since such funds are not subject to the new rules and can offer a stable share price. The same holds true for funds that invest in agencies such as Fannie Mae and Freddie Mac.
Doubtless some other administrators will just head for traditional banking, which at least offers the advantage of avoiding value-fluctuation recordkeeping, if nearly nothing in the way of returns. But the banks, subject to heavy-handed regulation themselves, are not going to be thrilled to receive all this new cash right now. Commercial loan demand is tepid and bank examiners impose unreasonable underwriting requirements that rule out many borrowers anyway. Some banks have already experimented with charging big customers for parking large sums in their accounts. And since deposit insurance is limited, large bank deposits are not without some degree of risk, too.
So what’s the big deal about pushing institutional and corporate investors to abandon money market funds? It isn’t one, as long as we don’t mind further choking off the supply of capital to medium and large businesses that routinely tap the money markets to finance inventory or plant expansions, or to accept large orders for which they won’t receive full payment until completion. It’s no big deal, if you don’t count losing the jobs that would be created, the retirement savings that would be generated and the taxes that would be underwritten by such profit-generating activity.
Of course, there is further irony in the fact that much of the money being pulled from institutional funds is being directed to the now-government-controlled housing agencies Fannie Mae and Freddie Mac, which underwrote the housing binge. That same housing binge, incidentally, caused the financial crash that triggered the failure of Lehman Brothers and the rest of the market meltdown in the first place. Lehman’s collapse led the Reserve Primary Fund to “break the buck,” which triggered the idea that money market funds needed reform.
Fannie and Freddie are the same two entities that the government seized as the price of its bailout. Now the government has tilted the playing field in its own favor, ensuring that it has a ready supply of cheap cash at the expense of the private sector. That state of affairs may not last indefinitely; Christina Kopec of Goldman Sachs Asset Management told The Wall Street Journal that corporate treasurers may move back out of government funds once the dust from the new rules settles. For now, though, assets under management at government money funds are up 72 percent from January as investors flee the broken private sector product.
The justifications for making money market funds “safer” by effectively destroying them are just as valid now as when the new rules were enacted – not at all. This is not merely a solution in search of a problem; it is a solution that is, itself, a problem. In this way, the rules are just one more element of an administration “legacy” of regulating that which it neither appreciates nor understands.