(MoneyWatch) COMMENTARY A long-simmering debate about the future of money market funds is heating up, as the SEC signals it wants changes that a fund industry executive on Monday said were "outrageous." The question, debated in Washington for nearly four years, is whether or not money market share prices should remain fixed at $1 per share, as they have since the first money market fund was created in the 1970s, or whether the share price should be required to "float" to reflect the value of the underlying securities it owns.
Arguing in favor of the fixed share price are fund managers and their trade group, the Investment Company Institute. They contend that a floating share price would scare investors away from money market funds, which would disrupt the financial markets and deprive corporate America of an important source of short-term capital.
Arguing in favor of a floating share price is, well, let's put it this way: When the Wall Street Journal's editors, the SEC chair, Paul Volcker, and a blue ribbon commission chartered by President Obama all come out in favor of a floating share price, it's safe to say that the idea has a broad base of support.
So how would such a change affect your money market funds? Other than potentially seeing the value fluctuate (very slightly), the most noticeable impact would be felt at tax time, when you might have to calculate capital gains or losses on market transactions. A bit of a bother? Yup. But a small price to pay to help prevent another bailout during the next financial crisis.
Why is this issue important? Because a fixed share price connotes safety and stability -- an investment that's free from volatility. But while those might be appropriate ways to describe money market funds most of the time, they don't apply all of the time. While it's not common, it is possible for the holdings of money market funds to decline enough that the fund is in danger of "breaking the buck" -- losing so much on its investments that it can't return $1 per share to its investors.
When this happens -- as it did with-- it can create a "run on the bank" mentality as investors scramble to pull their money out before an artificially high $1 share price is lowered. This puts even more downward pressure on prices as fund managers try to sell their holdings to meet these redemptions.
We saw precisely this vicious cycle in 2008, which required the federal government to take unprecedented steps to bail out the money market industry -- nine of the 10 largest money fund managers took loans from the Federal Reserve in order to meet soaring redemptions.
Many disinterested observers, including those named above, believe that steps should be taken to ensure that the government gets out of the business of rescuing private enterprise, which is why they support requiring money market funds to float their share prices. Floating share prices, the theory goes, would remove the compulsion for investors to rush for the exits in an attempt to receive an artificially inflated price for their investment.
Managers of money market funds fear that floating share prices will drive investors away, thus reducing their revenue. They've proposed their own solutions that have been back-tested to survive past crises; the problem is that back-tested solutions in the financial world have a bad habit of failing, as tomorrow's crisis often has little in common with yesterday's.
In my discussions with friends and colleagues in the industry over the past few years, I confess that I've been reminded of Upton Sinclair's quip that it's often difficult to get a man to understand something if he's paid a small fortune not to understand it. Their defenses are largely shallow, baldly self-serving, and almost inevitably end with the notion that there are so many more important things to worry about at this moment in history.
Be that as it may, my strong suspicion is that major change is coming in the money market industry. A forward-thinking mutual fund executive might recognize this reality and take steps to get in front of such reforms -- doing the right thing by choice before being required to by our nation's financial regulators.
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