Money market fund reform looks dead in the water

SEC Chairman Mary Schapiro / Getty Images

(MoneyWatch) COMMENTARY One of the few points of consensus in Washington following the 2008 financial crisis came when politicians, regulators and think-tank academics of all stripes agreed on the need to heed the lessons imparted by the worst U.S. economic calamity since the Great Depression. While doing so would not prevent future crises, it would at least help ensure that some of the factors that worsened the downturn would not play as large a part the next time the global economy went off the rails.

Among the early targets for reform were money market mutual funds, which played an undeniable role in the financial crisis. Money market funds -- which currently have nearly $2.6 trillion in assets -- are designed to offer investors a relatively low yield in exchange for a stable share price of $1. But unlike bank deposits, money market funds offer no insurance against default; there is, in other words, no formal guarantee that their investors will be able to withdraw $1 for every $1 they invest.

For much of the industry's 40 year history, this was viewed by many as a distinction without a difference, as money market fund managers sought to ensure that their funds never betrayed investor trust by "breaking the buck." In 2008, however, the fragility of this structure was made clear. The collapse of Lehman Brothers caused the Reserve Primary Fund to suffer significant losses, sending the fund's share price plunging to 97 cents.

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That, in turn, prompted a run on all money market funds, as investors sought to pull their money out before their own funds suffered a similar fate. In just one week, approximately 15 percent of all money fund assets were withdrawn.

This rush for the exits posed severe problems for the corporations that typically rely on money market funds to purchase their short-term debt, with the market for this debt essentially drying up overnight. In response, the U.S. Treasury Department took the unprecedented step of guaranteeing money fund investments, while the Federal Reserve purchased billions of dollars' worth of these suddenly illiquid securities so that the funds could meet redemption requests. Both steps bought the markets the breathing room they needed.

In order to prevent future government intervention, the SEC in 2010 required money market funds to keep more cash on hand in order to meet a sudden uptick in redemptions, a reform that money market managers supported.

That's where the agreement ends, however. SEC chairman Mary Schapiro argued that further steps were warranted and pushed for a rule requiring money market funds to adopt a floating share price, which would reflect the value of their underlying securities.

Shapiro's proposal was supported by both the Treasury Department and the Federal Reserve. (Demonstrating the need for such reform and the fragility of the $1 share price, the Boston Fed said in a study earlier this year that money market funds were bailed out by the managers that sponsor them to the tune of $4.4 billion in the five years ended 2011.)

Unsurprisingly, the money market fund industry was stridently opposed to such a change, arguing that it would result in investors pulling their assets out of money market funds in favor of less regulated alternatives.

Despite a furious lobbying campaign by the mutual fund industry, Schapiro forged ahead, and had tentatively scheduled a formal vote on this reform for next week. Those plans were scuttled when commissioner Luis Aguilar -- who previously served as general counselor for mutual fund manager Invesco -- said that he believed the issue required further study.

Calls for "further study," of course, are often Washington-speak for "I'm never voting for this," which is why Shapiro responded by urging that the issue be taken up by another regulatory body.

While that remains a possibility, the odds are long. The fact is that further money market reform suffered a serious blow last week, done in by a deep-pocketed opposition and regulators with short memories.

[jttuskan]

Nathan Hale's commentary does a great job of reciting the talking points that Securities and Exchange Commission Chairman Mary Schapiro relied on in her drive to restructure money market funds. His readers deserve to see what the majority of SEC commissioners who disagree with their chairman have to say in their recent public statements on the issue.

Commissioners Gallagher and Paredes raise serious concerns about a discourse "rife with misunderstandings and misconceptions." They conclude that "Chairman Schapiro's proposal is flawed because it is based on an incomplete perspective on the 2008 financial crisis ... and on the drivers of the financial run occurring in the midst of a crisis." They also acknowledge that "The Reserve Primary Fund did not 'break the buck' in a vacuum, but rather in the midst of a financial crisis of historic proportions."

Commissioners Gallagher and Paredes further discusses how the 2010 money market fund reforms dealt effectively with the serious financial market issues of the summer of 2011 and their significant concerns about the Chairman's Schapiro's proposal to float the $1 NAV.

A key point for Commissioner Aguilar is the potential impact of Chairman Schapiro's proposals. As he states, "I remain concerned that the chairman's proposal will be a catalyst for investors moving significant dollars from the regulated, transparent money market fund market into the dark, opaque, unregulated market."

Further, Commissioner Aguilar worries about the timing of these proposals saying, "I am also concerned that, given the current volatility of the capital markets and the fragile state of the economy, the timing of this proposal and its collateral consequences could be needlessly harmful."

These statements are a comprehensive and eloquent rebuttal to Chairman Schapiro and Mr. Hale and they should be required reading for anyone interested in a more factual perspective on 2008 and more realistic assessment of the proposals and money market fund sector in general. Links are below.

http://www.sec.gov/news/speech/2012/spch082812dmgtap.htm
http://www.sec.gov/news/speech/2012/spch082312laa.htm

J. T. Tuskan
Senior Vice President
Director of Marketing and
Corporate Communications
Federated Investors

[Rachel-McTague]

This Rachel McTague, media relations director at the Investment Company Institute.

Nathan Hale gets several things wrong about money market funds in this post.

1. Hale wrongly suggests that money market funds caused short-term credit markets to freeze during the crisis of 2008. This view ignores the fact that every market participant was in the midst of "the worst financial crisis in global history, including the Great Depression," as Federal Reserve Chairman Ben Bernanke has described. For more, see our recent post: "The False Narrative of 2008," available at http://www.ici.org/viewpoints/view_12_mmfs_misstatements_2

2. Hale darkly describes "a furious lobbying campaign by the mutual fund industry" but fails to mention the amazing outpouring of support for money market funds in recent years from hundreds of organizations across the private, public, and nonprofit sectors. Businesses, mayors, state treasurers, colleges and universities, investor advocates, and bipartisan groups in both the House and Senate -- they have all spoken out in favor of preserving the core features of money market funds.

3. Hale dismissively states that the issue of money market funds has progressed the way it has because regulators have "short memories." The truth is that a majority of commissioners at the SEC opposed pursuing flawed "structural" changes to money market funds. Like hundreds of other organizations that have submitted their views, ICI has strongly opposed the structural changes to money market funds under consideration at the SEC, because of the adverse consequences of these proposals for investors, issuers and the economy. The exhaustive record before the Commission clearly does not support these changes.

You can learn more about recent developments regarding money market funds, as well as the widespread support they enjoy from across the economy, at http://www.preservemoneymarketfunds.org/