Sunday, September 30, 2012

No Bank Runs Allowed

You might suppose that zero interest rates, and their attendant distorting effects on the capital markets, would be enough financial repression to last a lifetime, but you might be wrong.  This past week, our benevolent Secretary of the Treasury, Timothy Geithner, came out in favor of more repressive policies, this time targeted at money market fund investors.

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.