One of the biggest surprises to come out of the financial crisis was the so-called “breaking of the buck,” or when a few large money market funds (mutual funds for cash) dropped below a net asset value of $1 per share. Many investors didn’t realize that these investments weren’t savings accounts and began pulling money out in a panic.
The problem for the system is that money funds provide much needed and important liquidity. When they stopped buying short-term debt such as commercial paper, many companies found themselves without financing. And the rest, well, you know what happened.
So, Treasury Secretary Timothy Geithner outlined Tuesday proposals to regulate the $2.6 trillion industry. Here are a few details from the Bloomberg Businessweek story:
Geithner, speaking today in Washington at a meeting of the Financial Stability Oversight Council, a group formed by the Dodd-Frank Act and charged with addressing systemic financial risks, said the SEC should consider a plan for a capital buffer of 3 percent of assets that may be lowered if other steps are taken to reduce risk. Two other solutions Geithner offered are opposed by the funds industry and were rejected in August by a majority of SEC commissioners.
Representatives for the fund industry, who last month put forth their own plan to reach a compromise, rejected the proposals, saying they didn’t advance the debate. While Geithner has said the SEC is best positioned to address money funds, he has also said that the regulators’ panel, often referred to as FSOC, might intervene and subject funds to oversight by the Federal Reserve if the SEC fails to act.
Two of the options proposed by Geithner today included the major elements of a plan backed by SEC Chairman Mary Schapiro that she abandoned for lack of votes in August. That proposal would have given money funds a choice to either drop their traditional $1 share price for a floating value, or create capital buffers to absorb losses and temporary holdbacks on all withdrawals to discourage investor runs.
Here’s a clear explanation of the proposals from the Wall Street Journal:
One alternative is for money-market funds to float their prices along with the value of their holdings, rather than fixing values at $1 a share, as they currently do. With a so-called floating NAV, investors would be less likely to rush to pull their cash out of the funds before they “break the buck,” as happened during the 2008 crisis, regulators say.
The money-fund industry has opposed a floating-NAV solution, however, arguing that investors will lose confidence in the funds, which are commonly seen as tantamount to a bank deposit. Ms. Schapiro said in a statement at Tuesday’s meeting that the floating NAV is “the simplest option” and is the most consistent with broader SEC oversight of financial markets.
Another FSOC proposal: money funds could potentially maintain a stable NAV as long as they have a buffer of capital to absorb day-to-day fluctuations in value. Money-market funds have also opposed such a measure, which they say could cause the funds to become unprofitable and threaten the stability of the industry.
The third alternative includes a capital buffer as well as other measures, such as wide diversification of investments so the funds aren’t exposed to blowups of a single firm. The industry opposes this option as well.
Apparently, the industry doesn’t think there’s anything wrong here. According to the Journal, they want to impose fees on people who pull their money out during a crisis.
That seems problematic: they don’t want to put in place buffers to help create a more stable fund and then charge to pull out your money if it starts going south. I guess it’s not much different than a hedge fund, but these investments are marketed as safe. They have the reputation of being akin to savings accounts (whether deserved or not.)
Here’s a good point from the MarketWatch story:
According to reports citing people familiar with the industry, some money-fund firms have floated a proposal to the SEC that would prohibit investors from redeeming some money only when a fund is under stress.
However, the council in its proposal said it was concerned with such an approach, arguing that it could increase the potential for industry-wide pre-emptive runs by investors motivated to redeem their investments before restrictions are implemented.
At the same time the council is considering other approaches to limit the risk of money funds, including an approach that could designate some money funds as systemically risky and subject them to higher capital and liquidity requirements, according to a government official.
With the industry fighting to stay unregulated, it will be interesting to see the final outcome. Either way, the funds’ sterling reputation remains tarnished.