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 The Securities and Exchange Commission on Wednesday adopted new
rules aimed at forestalling runs on money market funds, notably one
which will force 'prime' institutional funds to allow their value to
float. The new rules also allow all money market funds finding
themselves short of liquid assets in stressed markets to impose
temporary impediments to redemptions or charge fees of up to 2
percent. Both sets of rules take effect in two years' time.
The rules fall ruefully short in that they exclude retail money
market funds, which will continue to be allowed to indulge in the
polite fiction that their value is stable at a dollar per share.
The dollar per share convention has unmoored investors,
institutional and retail, from the relationship between risk and
reward. The real value of all assets fluctuates, and the only
nominal values which can remain truly stable are those of securities
issued or insured by someone with the right to print money. Those
facts may raise the cost of doing business and raise the cost of
credit, but they remain facts nonetheless.
Policies, like the SEC’s, which attempt to finesse these facts will
either fail disastrously or end with the government picking up the
tab for private speculation.
That’s exactly what happened during the last financial crisis when
the well-known Reserve Fund, having invested in Lehman Brothers
debt, broke the buck, sparking a run on redemptions, mostly
institutional, on a range of money market funds. The illusion of
safety proved so strong that it created its own reality, as is so
often the case. The run only ended when the Federal Reserve and
Treasury agreed to provide temporary support to the funds, thereby
confirming investors' comfortable assumptions.
While defenders of excluding retail funds from floating their share
prices argue that it was institutional funds which prompted the run
last time round, this is well downstream of the point. The
fundamental error in the way the industry is constructed is that it
offers a product which investors equate with an insured bank
account, but which is no such thing.
It is also unclear that this new policy actually lessens the risk of
runs. While institutions won’t face a shock breaking of the buck,
all investors may now conceivably face the loss of access to their
money or a sizable penalty to get it back. That might prompt
front-running by investors seeking to get out ahead of impending
gates or fees. Big, savvy investors will get out first, while
smaller or less sophisticated ones will be left holding the bag, and
if push comes to shove the government will probably once again pick
up the check.
BETTER ALLOCATION, BETTER OUTCOMES
By allowing retail investors to continue kidding themselves about
the stability of their money market funds, we insulate them from the
consequences of their decisions in a way that makes credit markets
function less well.
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That’s not to say that the rule changes won’t carry costs. Some
institutional investors may decide to get out, favoring funds which
yield less but hold government securities.
Writing ahead of the well-flagged announcement, Bank of America
Merrill Lynch strategist Brian Smedley said:
“While final details are not yet known, we expect the changes to
drastically alter the money market investing landscape as the
reforms are implemented; we would not be surprised to see half a
trillion dollars move out of prime funds and into government funds
in the next couple of years.”
That will impose burdens on two groups: those who sell prime funds
and those who fund themselves through them. For the fund industry,
this is simply tough luck.
For borrowers, like local authorities, this means higher credit
costs but arguably better spending and investment decisions. The
cost of credit isn’t simply something to be manipulated to achieve
macroeconomic aims, it is a vital source of feedback. It is like a
nervous system, sending information from fingers touching a hot
stove to the brain.
Credit markets funded by people who think their money is insured are
indiscriminate. They don’t feel the burn until it is too late. That
means credit markets fail in their purpose of providing feedback to
borrowers about the safety or wisdom of their plans.
That lack of feedback was at the heart of the financial crisis. New
money fund rules only go part way in righting this wrong.
(At the time of publication James Saft did not own any direct
investments in securities mentioned in this article. He may be an
owner indirectly as an investor in a fund. You can email him at
jamessaft@jamessaft.com and find more columns at http://blogs.reuters.com/james-saft)
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