February 8, 2012
Fidelity Investments vehemently objects; Federated Investors even plans to sue the Securities and Exchange Commission. The object of their wrath? Proposed new rules for money-market mutual funds, the vehicles in which investors have parked cash that they want invested in ultra-safe and ultra-short-term investments.
The 2008 financial crisis highlighted the potential risks of these vehicles; when Lehman Brothers filed for bankruptcy, one money-market fund that held a lot of short-term Lehman debt was brought to its knees. The Federal Reserve had to pledge to prevent the money market funds from themselves going bust in order to sustain confidence in the industry – a step they don’t want to have to take again if another financial market crisis sparks a run on the funds and threatens their stability.
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Money markets are the side of the investment management business that doesn’t get a lot of scrutiny unless and until things go wrong. But it’s also the bedrock on which a lot of the relationship between investors and the businesses they back is constructed. To investors, money-market funds are where they park the funds they view as cash – the yield may be minimal, but they can sleep at night in the conviction that in return for the rock-bottom returns the risk is also as close to non-existent as possible. That capital is invested in short-term debt securities issued by corporations, who rely on it to meet immediate cash needs.
Now as regulators continue to work to close some of the holes revealed by the 2008 financial crisis, their proposals for money-market funds have ignited another fierce and furious debate –and again, the big question is whether the new rules would drive investors away and crimp credit availability for businesses.
The details of the rule changes will be revealed over the coming days, but it appears as if the SEC wants the companies that manage these funds – firms like Fidelity and Federated – to keep more capital as a reserve to meet any unexpected surge in investor redemptions, and to require shareholders to wait 30 days to get the last bit – up to 5 percent – of their money-market funds back after placing the order to sell. According to Fidelity, any attempt to impose this kind of “holdback” would mean that about half of retail investors would boycott money market funds; other proposals would result in up to 60 percent of institutions shunning the vehicles. If the proposals take effect, and hurt Federated’s business, CEO Christopher Donohue will sue the SEC, according to reports published by The Wall Street Journal.
The proposals raise two interesting questions. The first and most obvious one is, Will they work? If there is a market crisis, will new reserve requirements, a “hold back” provision and the ability for money-market funds to post a net asset value below $1 a share be enough to restore confidence and prevent a “run” on these investment products? The logic is sound – anything that creates a kind of firebreak in the midst of a market panic appears to be a good idea, assuming that people do react to it by hitting the pause button and considering whether there is real reason to panic. But the harsh truth of the matter is that we won’t know for sure until it has been tested. The benefits – if we are lucky – will remain hypothetical, meaning that only the costs become real and visible.
That doesn’t matter. We learned in 2008 that we shrug off sources of systemic risk at our peril, and the world of money-market funds is one such source.
If retail investors are reluctant to put their capital into money market funds, they can put it into bank accounts – given the incredibly low yields offered by both, most of them won’t be giving up that much risk-free income. The banks can then make the decision to finance short-term corporate paper, if they deem the risk-return calculus appropriate.
Maintaining the delusion that money markets can simultaneously rely on a government guarantee that the asset value won’t fall below $1 a share, while making their own decisions on what risky assets to invest in (European banks, anyone?) is a combination that isn’t going to go over well if any bailouts are required. If these are really funds like the other funds offered by Fidelity and Federated – pools of capital that can post losses as well as gains – they need to look like them. On the other hand, if they are really more akin to bank accounts, then the industry is simply going to have to tolerate more regulation.
Admittedly, there’s no easy solution to this problem. It will be hard for the banks to absorb a flood of new deposits, and banks aren’t set up to finance the kind of short-term commercial paper in which money-market funds have been primary investors. But it’s dangerous and foolish to underestimate Wall Street’s creativity.
If the banks can’t cope with the impact of new regulations and if a financing need remains unmet, it’s a near-certainty that someone out there will craft a new kind of investment product, one that doesn’t create the same kind of systemic risk that the SEC is trying to curb and that appeals to both investors and companies that need short-term capital. It’s useless to try and predict what that might look like today, but equally unproductive to shout that the sky is falling because the SEC tries to find a way to curb a source of what already has been shown to be a source of systemic risk in the financial system.