Mistaken Ideas about Money-Market Funds
Wednesday, July 18, 2012
Proposed regulations by the SEC are bad for investors, threaten the ability of money-market mutual funds to provide capital, and would pose serious economic risks.
For more than 40 years, money-market mutual funds have helped businesses, states, and municipalities meet their financial needs by purchasing their short-term debt.
But now, Washington bureaucrats threaten to impose major changes to the structure of these funds, supposedly to decrease risk in the financial system. Remarkably, the current discussion comes just two years after the Securities and Exchange Commission tightened credit standards, shortened maturities, and increased disclosure requirements for money-market mutual fund assets.
The suggested changes are bad for investors, threaten the ability of money-market mutual funds to provide capital, and pose serious economic risks.
One change would require funds to publish the value of the funds’ shares at more specific prices, rather than rounding their net asset value (NAV) to the nearest penny as they do currently. The intent of the proposed change is to highlight the technicality that the funds’ NAV actually “floats” within a very narrow range around a dollar. However, because these historical variances are so immaterial and temporary (usually from 1/5 to 1/10 of a penny or less) money-market mutual funds report their prices just as every other mutual fund does—rounding to the nearest penny. Reporting prices to a tenth of a penny just for floating’s sake would force costly new accounting and tax reporting for all investors and would prevent many institutions and government entities from investing in the funds. Is that worth showing a change of $0.001 per day in share prices?
Another change would require funds to hold aside some of investors’ cash as “capital,” rather than investing it. This is an odd idea, because capital reserves are typically used to alleviate risk associated with lending or investing with leveraged equity, and money-market mutual funds are not leveraged. Moreover, if funds are required to hold excess capital, companies and governments will have to pay more to obtain financing from these funds because the funds will raise their yield requirements to offset income lost on an idle capital reserve.
A third change would limit fund investors’ right to receive all their money upon redemption of their shares. Such a restriction would conflict with liquidity requirements in the investment policies of many government and institutional investors and would destroy a key benefit for all investors seeking modest market returns in exchange for flexibility and liquidity.
Most troubling is that these changes now being aired are not based on any claim that the funds fail to serve their investors or operate outside SEC parameters.
Most troubling is that these changes now being aired are not based on any claim that the funds fail to serve their investors or operate outside SEC parameters. Instead, proponents claim to be in hot pursuit of hypothetical “systemic risks” that supposedly arise from the mere existence of this decades-old investment vehicle. They suggest that the structure of money-market mutual funds led to “runs” in 2008—excessive investor withdrawals that left the funds unable to make their normal investments, including buying bank-related debt. When few other investors were willing to invest in bank-related debt in the autumn of 2008, bank regulators were not pleased, because their job of trying to keep the banks afloat became harder.
Calling the structure of money-market mutual funds a systemic risk that justifies fundamentally changing this well-established investment vehicle is a gross overreach based on a faulty premise. When money-market mutual funds make portfolio determinations about the appropriateness of specific investments, such as avoiding exposure to a large bank, they are acting as prudent managers of their investors’ assets in accordance with 2010 SEC reforms. Are bureaucrats really suggesting that investors’ money must remain at risk in the name of stability?
Yale professor Jonathan Macey studied the 2008 crisis and found that the single money-market mutual fund failure during that period “did not precipitate the crisis” but rather was “a manifestation of the crisis.” (Investors later recouped over 99 cents on the dollar from the fund, an outcome that surely would have been welcomed by many other investors that year.) Keep in mind that this occurred during a virtual shutdown in most traditional lending markets; many banks did not lend even to one another overnight, despite unprecedented efforts of the Fed and Treasury.
The sole money-market mutual fund failure since 2007 stands in marked contrast to the 448 federally regulated depository institutions that failed during that time at a cost estimated by the FDIC to exceed $80 billion. Federal regulators now seeking to impose restrictions on these funds should not be surprised if, in light of recent experience with extensively regulated institutions, they are asked to substantiate the merits of their desire to restructure the entire money-market mutual fund industry. Apart from employing the elastic epithet of “systemic risk,” they have yet to do so.
Reporting prices to a tenth of a penny just for floating’s sake would force costly new accounting and tax reporting for all investors.
In fact, although SEC Chairman Mary Schapiro alleged in recent congressional testimony that sponsors of money-market mutual funds had voluntarily helped their funds “on more than 300 occasions” during the past 40 years, the SEC and other banking regulators have been surprisingly unspecific in detailing just what the “systemic risk” of these funds might be—including failing to make public these 300 instances. Because the holdings of money-market mutual funds tend to be very short-term and privately offered, these assets largely lack a liquid trading market; in contrast, most equity and bond mutual funds’ holdings tend to be securities traded in more liquid public markets. In the absence of this kind of trading market, money-market mutual fund sponsors are more likely to interact with funds in all sorts of ways to smooth their operations and funding patterns. Even during the worst financial distress in 100 years, these fund-management practices continued to operate for the benefit of fund investors.
If the SEC cannot meet its institutional responsibility to establish a compelling justification for further action—one based on conclusive proof of the insufficiency of the 2010 reforms and a weighing of the substantial costs to financial markets—it should decline to make risky and disruptive changes to the money-market mutual fund rules it adopted just two years ago.
Let’s be clear: Businesses, investors, workers, and consumers alike would bear the costs of this ill-advised bureaucratic action that is based on an imprudent claim of systemic risk to our financial system.
Paul S. Atkins is a visiting scholar at the American Enterprise Institute and served as a commissioner of the Securities and Exchange Commission from 2002 to 2008. He is now CEO of Patomak Global Partners in Washington, D.C., which represents clients’ interests in the United States and abroad, including money market activities.
FURTHER READING: Atkins also writes “On Fixing the Watchdog: Legislative Proposals to Improve and Enhance the SEC,” “Enhancing Investor Protection after the Financial Crisis,” and “TARP Was No Win for the Taxpayers.” The Shadow Financial Regulatory Committee reports “Regulation of Money Market Mutual Funds and Systemic Risk.” Peter J. Wallison contributes “The Financial Crisis on Trial.