Once upon a time, yours truly was the head of the fixed income department of a money management arm of a large money center bank. As head of fixed income, I had responsibility for all fixed income (bond, in common, but not precise, parlance) assets with maturities greater than one year, so my area of responsibility did not include money market funds. However, back in the early ‘90s, the money market funds encountered some, er, difficulty, as did several larger money market funds at the time. When the funds “broke the buck,” i.e., their net asset values (“NAV ”s) fell below the perceptually guaranteed $1.00 per share, and the bank holding company had to bail out the money funds, the guy who oversaw the money fund operation was summarily fired and was replaced by the logical guy, yours truly. Having only had limited experience with money funds, but being a decent manager, I left the technical details of ironing out our problems to a very good operational money fund guy who had had no part in the funds’ demise. I oversaw his work, but left it in his very competent hands. We worked through the problems and it was far tougher on the operations guy than it was on yours truly, largely because he had been around when the problems arose and the problems were far deeper, though, again, did not involve him, than those encountered by other money funds that were breaking the buck at the time. The ending was happy; the funds were restored to health, the bank holding company came out even, the business was restored, and yours truly got a lot more credit than he deserved. But the guy whom I effectively put, or left, in charge of unwinding these things also did quite well as a consequence, though not as well as he should have.
I tell that story, as vaguely as I can, because it establishes both my interest in and bona fides for discussing the Security and Exchange Commission’s (“SEC ”’s) latest machinations in the money fund industry.
The SEC yesterday approved a proposal requiring prime money market funds, which are money funds that cater primarily to institutional investors and that don’t restrict their purchases to government paper, to float their share prices, i.e., to not stick to a fixed $1.00 share price. The new rule is the latest, though probably not the final, product of the machinations of the SEC , at the prodding of Congress, the Fed, and the Administration, to address the systemic risk that lurks like a time bomb in the $2.6 trillion money fund industry. When the financial system encountered its problems in 2008-’09, money funds were one of the centers of the difficulty; when the Primary Reserve Fund, a prime money market fund, broke the buck, the fear was that the entire industry would face a run almost straight out of “It’s a Wonderful Life.” The federal government ultimately guaranteed money fund assets, as it does bank deposits, until the danger passed…temporarily. The SEC was charged with addressing the underlying issue of the safety of the money fund industry and to institute measures that would prevent, or at least avoid, money fund runs.
Three major approaches were proposed:
- Requiring money fund share prices float rather than be held at $1.00.
- Requiring money funds to hold capital, like banks, that would provide a buffer for shareholders.
- Imposing redemption restrictions on money fund shareholders, either temporarily in times of difficulty or all the time.
The mutual fund industry didn’t like any of these proposals for obvious reasons, screamed and yelled, kicked and screamed, and put their considerable lobbying power to work. The industry succeeded in delaying any of the proposed restrictions, until yesterday. But the pressure remains for further safeguards in the industry. The SEC , kindred agencies, the Congress, and the Fed remain very interested in this issue, so work will continue on something that will be trumpeted as an ultimate solution until either another problem, or another solution in search of a problem, arises.
The ideal solution to those of us who feel that markets work would be to make clear to money fund shareholders and potential shareholders that money market funds are not bank accounts but are, as their name indicates, mutual funds and that, as such, their values are subject to fluctuation. And if they get in trouble, it looks like YOU, Mr. Shareholder, not the taxpayers, have a problem. The government will not rescue errant money funds. So caveat emptor. If you want absolute safety, put your money in a bank and be mindful of the FDIC insurance limits.
The above market based solution will not be implemented, however, because there is no way the government will not bail out the industry, and the shareholders, if trouble arises again; $2.6 trillion perched at vital intersections of the financial system will not be allowed to fail. Thus the above three alternatives.
Which of the above “solutions” would be best? Being a believer in markets, and a man who tries to look reality squarely in the face rather than pretend it isn’t in the room, I like the idea of extending to all money market funds the floating share price that the SEC mandated for prime funds. The underlying share prices do indeed fluctuate, usually only by small fractions of a penny, but they do fluctuate and sometimes by more than half a penny, which would round to an NAV above or below a dollar. So what? Again, these are mutual funds, not bank accounts. While the industry has gotten quite fat on the notion that money funds are the equivalent of bank accounts, that notion is wrong, though never discouraged, certainly not by the mutual fund industry. Better to face reality and let the share price float.
The result of a more general float will be either or a combination of
· The better, safer funds will tighten things up and indeed keep their NAVs at $1.00, probably at the expense of some yield.
· The more adventurous, or less well run, funds will allow their NAVs to float slightly and will either go out of business or attract investors who are willing to accept some share price fluctuation in exchange for more yield.
What would be so bad about that?
Barring an NAV float, the next best alternative would be to impose redemption restrictions on fund shareholders. For example, fund holder would be able to redeem X% of their shares immediately, Y% of their funds with 7 days notice, and Z% of their funds with 30 days notice. This would give fund managers the ability to manager the funds’ liquidity and meet redemptions without causing market turbulence. It would also reinforce the notion that money funds are mutual funds rather than bank accounts.
The SEC is indeed proposing redemption restrictions for prime funds, but the SEC , in addition to limiting these restrictions to prime funds, would like to impose the restrictions temporarily and only during times of trouble. This would be counterproductive, not avoiding runs but expediting runs as shareholders attempt to redeem shares before such restrictions are implemented. Permanent restrictions would allow for orderly meeting of redemption demands while keeping things calm, or as calm as possible.
Capital requirements are probably a non-starter, especially while we are still in the throes of Ben Bernanke’s War on the Elderly in which there is no yield to be had in short term investments in any case. Fund families are waiving fees and losing money on money funds; requiring them to hold capital would exacerbate the situation, doubtless forcing people out of business in bad times and making yields uncompetitive in good times, defined in this case as times of high yields in short term instruments. While some might justifiably argue “So what if the market winnows out weak performers, or a weak product, that can’t compete on level playing field with banks that must hold capital?”, the comparison to banks is not apples and oranges here and, in any case, the industry would never go along with such a rule.
The key point here is not that yours truly, who knows something about money funds, likes floating NAVs or redemption restrictions for such funds, certainly more than I like capital requirements. The point is that ANYTHING the SEC or other powers that be does about money market funds MUST reinforce the distinction between such funds and bank depository accounts. The reality is that money market funds, contrary to popular opinion, are not bank accounts and are not insured by the federal government, at least not when the defecatory product stays away from the wind motivation device. Potential investors who think they are savers have to be made aware of that reality. Withdrawal restrictions or a floating NAV would accomplish that goal.
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