Reforming Money Market Funds
Government financial overseers have for some time been
reviewing a proposal to make money market funds less vulnerable to the systemic
risks that plague our world, and which might otherwise lead funds to
"break the buck" with shareholders.
The stated objective is to limit runs on money market funds that might
further destabilize the financial system during periods of financial panic.
Apparently, the Securities and Exchange Commission was not
convinced that this proposal was the right way to achieve that end, and it
declined to act. Such caution was not in
Secretary Geithner's playbook, so he went over the head of the SEC and this past
week issued a letter to the Financial Stability Oversight Council urging
action.
Geithner's letter said that, without this measure, “our financial
system will remain vulnerable to runs and instability.” Although stability is a very laudable goal, we
know that the Secretary and his friends have tended to go overboard before, and
so maybe we ought to examine this proposal before he gets his way
What Would Happen to Your Money
Among the proposed "reforms" are features that
provide a floating price for a money market fund. That would work by defining a fraction of
each investor's balance as the "minimum balance at risk", which would
absorb losses if the fund was liquidated.
Redemptions of the minimum balance at risk would be delayed by 30
days. In the event of an imminent
financial crisis, this would force investors to remain partially invested in
the fund long enough "to share in any imminent portfolio losses or costs
of their redemptions." In other
words, no bank runs allowed.
What Would Not Change
Of course, even today investors in money market funds are not
immune to loss, and the new rules would not change this. Even under present rules, another crisis
could arise suddenly and "break the buck" before any money market
shareholder could react by withdrawing funds.
On the other hand, people who observe the financial landscape
and actively manage their investments might in some circumstances be forced by
the new rules to take losses that they could otherwise avoid if the financial system
visibly destabilizes over a period of weeks or days. Of course, people always think that they can
get out of the door before the rest of the crowd, and a 30 day redemption delay
might or might not make a difference in individual outcomes.
This Benefits the Banks, Not You
It is easy to predict that risk-averse people will withdraw
money from money market funds and move them to safer investments if this
proposal is adopted. An official
acknowledgement of the risks to money market funds would likely change investor
perceptions and might prompt many to move their money elsewhere. Maybe this is what Geithner and his friends
in the financial community want.
It is easy to see who will benefit. Risk-averse people would move money into insured
bank deposits, on which the banks pay very little interest. In other words, the proposed new rules would
provide the banks with very cheap new funds.
With about $2.7 trillion in money market funds, this could provide the
banks with a huge amount of cheap new funds.
Cheap, new funds are exactly what the banks need to improve
their balance sheets and continue their recovery from the financial crash --
and continue raking in profits at the expense of
American savers.
Of course the banks want your money market fund. When the next "Lehman moment" hits,
do you think the American people will allow their elected representatives to
vote more money for the banks again? Maybe the banks will need your money market
fund.
A Signal That All Is Not Well
This is not to say that all the money withdrawn from money
market funds will go to the banks. Maybe
some will go into Treasury bills, and maybe some will look for other
havens. Jesse's Cafe
Americain
wrote: "I
think quite a bit will go into gold and silver as people sicken of the
financial repression of the Banks and their friends".
It makes sense. Money
market funds have long been seen as a safe investment. If the government changes the rules on money
market funds, it will be a signal to the American people that
something is wrong. It will become
more evident to shareholders that the financial system is not yet
healed, that systemic risk remains high, and that the government has been
extending and pretending. It may even
become clear that nothing has been done to solve the basic problems of
indebtedness and leverage that got us into this mess. People look for ultimate havens in
circumstances like that.
The Zero Hedge blog
started to raise the alarm on the proposed "reform" of money market
funds starting about two years ago, and they revisited the topic this past week
when Geithner's letter appeared. I have
no idea if the rules will be adopted, but the appearance of Geithner's letter
shows that official circles are still highly concerned.
