Killing Fundamental Reform: Money Market Funds
Today money market funds are like pilotless airplanes. The money manager operates the fund from the safety of his office. As long as markets are stable, the passengers (investors) are just fine. If the fund encounters a turbulent patch, the investors are at risk. In a financial crisis, all those pilotless drones pose a risk to the financial system. Over the last several years, the government was supposed to do something about this.
|Angel Investing 1 (2001)|
This post illustrates the power of the money management industry to oppose and stall regulation even when there is an overwhelming problem that threatens our long-term financial stability.
When you deposit money in a money market fund, you expect that you’ll get every one of your dollars back whenever you want. During the credit crisis, many money market funds incurred losses and faced the choice of freezing the fund (no or limited withdrawals) or returning less than a dollar to their investors. The government stepped in to guarantee everyone’s principal in money market funds, and everyone breathed a sigh of relief.
However, a government guarantee is an entirely inappropriate way to protect investors, as it gives the money manager license to make inappropriate and risky bets. If his bets don’t work out, the taxpayers will be forced to bailout the money market fund. Money market funds aren’t bank deposits, and thus shouldn’t enjoy the type of protection offered by the FDIC. Moreover, taxpayers do not fund the FDIC’s guarantee. It is covered by premiums paid by the banks.
In 2009, the SEC adopted a series of reforms to require money managers to invest money market funds more conservatively. Later in 2009, the SEC sought comment on methods of protecting mutual fund investors during periods of crisis. After numerous meetings, roundtables, and comment periods, the SEC tried to bring forward two concepts (not even proposed rules) in September of this year. The mutual fund industry vehemently opposed both concepts, and the SEC chairman was unable to muster the three votes necessary even to put them forward.
Here are the two ideas. First, the SEC wanted to propose that the value of a money market fund float, just like every other mutual fund. Under normal circumstances, you’d get your dollar back, but in times of stress you’d simply get whatever the fund was worth (e.g. 94¢ or 95¢ on the dollar). The industry, of course, fears that folks like you wouldn’t invest in money market funds if this concept were adopted. I have to admit that I would reduce my money market balances if this idea became a rule.
The second idea would require money market funds to hold 1% of their assets in cash (with more cash set aside if the fund’s strategy is riskier) as a buffer and require it to pay 97¢ in times of distress and the remaining 3¢ within 30 days of the withdrawal request. The industry objected to this idea, because it would hurt yields (the cash wouldn’t earn a return) and therefore diminish the marketability of money market funds.
After the SEC’s proposal collapsed, pressure quickly built. It’s been over three years and nothing has been done to address the liquidity problems of money market funds in periods of the distress. The Federal Stability Oversight Committee created by Dodd-Frank threatened to have the Federal Reserve regulate money market funds if the SEC cannot promulgate reform measures. This threat got the industry to respond and re-initiate discussions. The industry has proposed that investors should pay an “exit charge” of 1% or 2% during periods of distress. In other words, if a money market fund is in distress, you’d have to pay a fee in order to get your money. I’m not surprised by this proposal as it puts the entire burden on you and none on the industry. The manager should be managing risk instead of imposing the risk on money market investors.
I have an idea that the SEC should adopt. It’s an idea the industry will hate. Money managers should have to put a percentage of their own money into their money market funds. The money should come from both the corporate sponsor (a bank, insurance company, or mutual fund advisor) as well as the senior executives. If the fund enters a period of distress, the firm and the money managers should be the last ones permitted to exit the fund. Under my proposal, the airplane would not longer be pilotless. We’d have a captain onboard, and he would be the last one to go down the emergency chute in the event of a water landing.