New money fund rules keep illusions alive
July 23 (Reuters) – New money market fund reforms are half
measures which will fail to end investors’ illusion that there
is such a thing as a safe asset.
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
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’
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.
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
That lack of feedback was at the heart of the financial
crisis. New money fund rules only go part way in righting this
(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 email@example.com and find more columns at blogs.reuters.com/james-saft)