Money-Market Funds

As Safe as Banks, Except When They're Not

currencies-dark

Money-market funds have long been one of the world’s most popular investment products, and why not? For 40 years, they offered better returns than bank deposits, were just as accessible and seemed just as safe. That illusion came to an end in September 2008, when Reserve Primary Fund, the oldest U.S. money-market fund, collapsed. A debilitating run on other money funds ensued, threatening chaos for the banks and big corporations that relied on short-term loans from the funds to pay their day-to-day bills. After years of debate, the U.S. Securities and Exchange Commission in 2014 passed a set of rules aimed at making the funds safer without destroying their utility to investors and borrowers. The rules are weaker than its original proposals, which had been backed by the Treasury Department and Federal Reserve but ran into fierce industry opposition. Some critics think the SEC backed down so much that it has failed to build a firewall between the funds and the rest of the economy. Some in the industry say the unintended consequences are just beginning to be felt.

The Situation

In July 2014, the SEC approved new guidelines that will — for some funds — alter one of the industry’s most hallowed traditions: pegging the price of a fund share at a constant $1, a sign of stability the industry sees as crucial to reassuring customers. Funds for individual investors and those that buy only debt issued or backed by the U.S. government can stick with the $1 share price. But by 2016, funds that cater to institutions and that buy corporate debt will have to let their share price float to reflect the actual value of their holdings down to four decimal places. The idea is to make investors less likely to flee if they think a fund is wobbling. As a second safeguard against runs, the commission empowered fund boards to limit or penalize withdrawals during times of stress. The European Union is considering a similar approach after dropping tougher measures. In response to the SEC rules, some funds plan to focus solely on safer investments. Others, including industry giants BlackRock and Federated, began mulling moving their biggest clients into private funds with a fixed share price — that would not be subject to the SEC rules.

Source: Investment Company Institute
Source: Investment Company Institute

The Background

Money market funds were born in 1971 as an alternative to bank deposits, whose interest rates were capped by the government. But the crisis of 2008 focused regulators on the funds’ role as the largest source of short-term corporate loans known as commercial paper that are used for day-to-day credit by most big companies. Only a federal bailout that put taxpayers on the hook for trillions of dollars saved the funds, and  the broader credit markets. To stamp out this systemic risk, Mary Schapiro, the SEC chairwoman in 2012, proposed that fund boards choose between either floating their share price or creating capital buffers to absorb losses. Schapiro was forced to abandon the plan after intensive lobbying by the industry. An U.S. intra-agency panel that includes the Fed and Treasury then threatened to pursue its own remedies if the SEC failed to act.

The Argument

The industry argued that Schapiro’s plan was unnecessary because smaller changes required by the SEC in 2010 had already addressed safety issues. And a floating share price or withdrawal limits, they said, would drive away customers or could create upheaval in the $1 trillion market for commercial paper. The proposals by BlackRock and Federated for private pools might only be the first of many changes that could send billions beyond the SEC’s regulatory reach. Sheila Bair, the former FDIC chairman and another crisis veteran, agreed with other critics who said the new rules don’t go far enough. They see the $1-a-share price as an incentive to run for the exits at the first sign of trouble because “breaking the buck” is seen as so dire an event. That leaves those who would leave more slowly — most likely small investors — to absorb losses.

The Reference Shelf

  • A research report by BNY Mellon comparing the U.S. and EU proposals and an analysis from lawfirm Stradley Ronon on the new U.S. rules.
  • The EU’s proposal for regulating funds.
  • While Schapiro was preparing her plan, the Investment Company Institute addressed the question, “Do Money Markets Pose  Systemic Risk?”
  • After the Schapiro plan died in August 2012, the Financial Stability Oversight Council prepared its own recommendations for money-market fund reform.
  • In December 2012, the SEC staff delivered this report to the three commissioners who had voted against the Schapiro plan.
  • The June 2013 proposal drew more than 1,000 public comments.

First Published April 23, 2014

To contact the writer of this QuickTake:

Christopher Condon in Boston at ccondon4@bloomberg.net

To contact the editor responsible for this QuickTake:

John O'Neil at joneil18@bloomberg.net