Are Money Market Reforms Coming?
For the past few years, money market managers have been eyeing regulators warily. Money market reforms have been rumored, speculated about, and even offered by fund managers themselves. That reforms of some sort are coming is taken as a given; what's unknown is just how disruptive they'll be.
Those reforms have the potential to put a significant dent in the profits of fund managers, which is why the Investment Company Institute -- which represents fund managers -- has been operating with a bit of a hair trigger in responding to nearly any suggestion that reform include a floating share price.
This sensitivity was on display this week when the ICI published a list of facts that it believes were missing from a Wall Street Journal column that suggested that money market funds have to abandon their $1 fixed share price.
That fixed share price is ground zero in this debate. Why? Because on one hand, it conveys a sense of stability. Even though each money market prospectus includes language that makes it clear that the funds are not FDIC insured and could lose value, the fact is that many investors use money market funds for their short-term savings because they expect them to maintain that stable share price. That the ICI has been arguing so vociferously against a floating share price is all the evidence you need to confirm this reality.
But on the other hand, the sense of stability that's conveyed by that stable share price is false. Money market funds own marketable securities -- corporate- and government-issued debt -- that rise and fall in value. Because there are limits on the credit quality and maturity of the debt these funds may own, those rising and falling values are so slight that it's not difficult for the funds to maintain that $1 share price -- most of the time.
But we live in a messy world, and from time to time stuff happens -- unforeseen stuff like recessions, bankruptcies, credit crunches, and liquidity events. In the vast majority of cases, when a money market manager got caught reaching a bit too far to boost their fund's yield and ended up endangering their fund's $1 share price, the parent firm stepped in and provided the capital needed to preserve the status quo.
But in 2008, when Lehman Brothers collapsed, the industry's oldest money market fund suffered losses that outstripped what the firm could absorb, and the fund became the third in the industry's history to break the buck.
That, along with the unprecedented liquidity crisis that we were treated to in those days, combined to put a severe strain on the entire money market fund industry. Money market fund investors knew that liquidity was scarce, and didn't know which large financial institution might fail next. They were also highly motivated to redeem their money market shares as quickly as possible -- before their own fund ended up breaking the buck.
To meet these redemptions, fund managers had to sell the funds' underlying securities. The problem is that there were very few buyers, and prices began to fall, putting more pressure on the funds' share price. Further, the increased redemptions meant that there was very little demand for the short-term debt that corporate America has come to depend upon to fund their day-to-day operations.
This liquidity freeze compelled the Treasury Department to step in, offering money market funds insurance against breaking the buck.
The crisis passed, of course, and the industry and its investors emerged relatively unscathed. But it left many wondering what reforms should be undertaken in order to ensure that the federal government doesn't have to step in to prevent a future collapse.
Reformers argue that requiring money market funds to float their share price will de-incentivize investors from pulling out of money market funds at the first sign of trouble: if you know that the price you sell at will reflect the true value of the underlying securities, there's little motivation to be first in line at the bank, and a larger motivation to sit tight and wait until the storm passes.
But what if a large contingent of money market investors would spurn money market funds with a floating share price? While that might be good news for the savings institutions that would presumably receive those assets, such a shift would have significant implications for corporate America, who count on money market funds as a ready buyer for a tremendous share of their short-term debt.
There are no easy answers for these questions, which is probably why it's taken regulators so long to develop a list of proposed reforms. What form those reforms ultimately take is unknown. But what is known is that there's little appetite in Washington -- or the rest of America for that matter -- for the federal government to have to step in again anytime soon to save a private sector. Which is why, if I were a betting man, I'd wager that the days of fixed share prices for all money market funds are numbered.
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