Money Market Fund Reform: Short-Term Stability vs. Long-Term Security
One of my first jobs as I was getting started in the financial markets was to place trades in retirement accounts and workplace retirement programs.
Shareholders, at various times, would call or show up to ask how they could keep their money safe. Maybe they were nearing retirement or saw something on T.V. or read something in the paper (as this was before the internet became so popular).
They always said, “What can I put my money in to keep it safe?” We were instructed to answer that our money market funds were their best option. And then we added our catchphrase, “If this thing goes under a dollar a share, you have more things to worry about than your retirement.”
Today it seems surreal. I don’t think any of us thought we would see the day that those shares went under a dollar, but it happened back in 2008. And now, one of the biggest discussions on Wall Street and on Capitol Hill is about money market fund reform.
Today I’m going to update you on what’s going on and how it may affect what investors for a long time assumed was a “safe” investment…
Understanding Money Market Funds
Money market funds are kind of like cash investments that are set up to provide safety for investors. The objective is to give you some interest while maintaining a net asset value (NAV) of $1 per share. The funds are made up of short-term – usually less than 12 months – securities representing top-quality, very liquid debt and monetary instruments.
But something happened four years ago during the crisis. On September 16, 2008, the Reserve Primary Fund’s NAV fell to $0.97. It was one the first times ever that a money market fund fell below a $1. The industry lost its mind.
The Reserve, a New York-based fund manager specializing in money markets, held $64.8 billion in assets in its storied Reserve Primary Fund. It had invested debt in Lehman Brothers Holdings Inc. that became worthless when they went bankrupt. In actuality, Lehman paper represented only about 1.5% of the fund’s total assets. But investors then questioned the value of the other holdings. Then the run was on…
What Could Be Changed?
New regulations would require money market funds to decide on a course of action. They could either put aside a determined capital requirement or the fund can "float" its NAV.
Floating the net asset value would mean that money market funds would be priced like regular mutual funds and could not fix at $1. In other words, its price would be based on its underlying assets.
Late last month, money market mutual fund reform was brought back into the financial services arena. SEC Chairman Mary Schapiro began the fight for the above-mentioned regulation changes, but lost the battle to the money market fund industry and her own fell SEC commissioners in August.
However, a month later, the Financial Stability Oversight Council, (FSOC) – formed by the 2010 Dodd-Frank legislation and chaired by Treasury Secretary Tim Geithner – stated in a release that they were continuing to discuss the subject. They would release more information during their November meeting.
This could have been expected. Secretary Geithner said last month that the FSOC was going to see if money market funds could be considered "systemically important." If the funds are put in this category, they would be subject to tighter regulations and oversight by the Federal Reserve.
Secretary Geithner has introduced or hinted to rule changes that would force money market funds to change how they report their NAV.
Fund companies say they like business as usual – where they would continue to be under the oversight of the SEC. A Treasury official said that the current structure of the industry presents a "serious threat" to financial market stability. Weeks ago the industry thought it gained a big feather under its cap with a regulation win when Chairman Schapiro was defeated. It seems like that was just round one.
The Argument for Both Sides?
Chairman Schapiro's purpose in pushing for a floating NAV was to allow for more transparency. The $1 per share aspect, in truth, is a myth. The Chairman’s hope is that changes in NAVs will allow investors to get used to its reality. If this happens, hopefully you won’t see run on money market funds during downturns.
The financial industry believes any changes will cause exactly what Schapiro and Secretary Geithner are trying to avoid. They say a floating NAV would cause a short-term panic in money market funds – just like what happened in 2008.
The Association for Financial Professionals, for instance, has said: "We oppose the proposal to eliminate the stable NAV in favor of a floating NAV, as we believe it would greatly reduce investors' interest in utilizing [money market funds] as a cash management and investment tool . . ."
Since September 2008, money market funds assets under management have dropped from $3.5 trillion to $2.55 trillion as of August of this year. The industry is still in bad shape and isn’t sure how it will recover.
How Does it Affect You?
If you really look at it, if funds did begin to float their NAVs, most of the deviations would be so small the average investor would never see the difference.
It would most likely be seen and felt by big institutional investors. But that’s what causes those big, systemic issues, and we’ve already seen what they can do.
I do believe that in the long term investors would see that the fluctuations are only blips, and most would carry on with business, as usual. Whether these are a great investment idea right now though, is a totally different argument.
For more about the inner workings and dangers of money market funds, check out Alexander Green’s article from earlier this year, When the Safest Investments Turn Risky.