Is it time to clamp down on money funds?

June 20, 2011

Money market mutual funds are an institution “vulnerable to a crisis…(with) no backstop … no capital … (and) no official liquidity support,“ Paul A. Volcker, former Federal Reserve Board chairman who had recently served a 2-year term as chairman of President Barack Obama’s Economic Recovery Advisory Board, said last month.

“What is the public good that this institution is providing that makes it worthwhile to run a big risk: vulnerability to a crisis?”

He was speaking at a Securities and Exchange Commission discussion of another truckload of proposed regulations — intended, like a now-effective 2010 set, to prevent a recurrence of the September 2008 “run” on such funds — after joking about his long service to the country by identifying himself as having been “once in a while with the Federal Reserve.” The SEC is considering further regulations on money market mutual funds but there are no indications that any formal proposals will be made soon.

It seems like we’ve seen this film before.

It was way back in 1981 that Volcker said “money market funds] are becoming … more like banks … but they do not operate under the disabilities that banks and thrift institutions do.”  He said “the question, obviously, is whether (the same constraints) are appropriate for money market funds, too.”

Back then, as Fed chairman, he was asking Congress for the authority to impose reserve requirements on money market fund accounts from which shareholders could “make withdrawals.” He never got it.

Fast forward 30 years, past the 2008 credit crisis, and he’s still saying that money funds should face bank-like requirements on capital reserves and liquidity.  Maybe, this time, he’ll win. One proposal being considered would regulate money funds as special-purpose banks.

But the counter argument has been made, too: Shouldn’t regulators and shareholders have longer experience with the SEC’s newly acquired weapons before having to deal with new ones?

In thinking about all this, remember a few things.

1. Money market funds are managed to provide a stable share price of $1.00, but they cannot guarantee it — and must say so in their literature. That stable share price isn’t guaranteed by the government, either.

2. Prices of the short-term securities in which the funds invest fluctuate, but they fluctuate so little that, the $1.00 price should be maintained when those prices are rounded in accordance with current regulation.

3. When funds’ investment advisers have faced the possibility of “breaking the buck” in the past, they have put up capital or obtained money from affiliates or others to prevent it.

Until 2008, except for only one small institutional fund long ago, no fund broke the buck. But in the wake of the Lehman Brother bankruptcy in 2008, the Reserve Primary Fund (ironically the original money fund) had to price its shares at 97 cents on September 16, 2008. It lacked the resources to bolster the fund when its Lehman holdings plunged.

In the aftermath of that, the SEC passed a 60-page comprehensive money market reform package of regulations early in 2010. Its major components dealt with portfolio quality, maturity, liquidity, disclosures and the orderly liquidation when necessary, as in 2008.

At that time, SEC Commissioner Chairman Mary Schapiro called it a “first step.” There was another reform package was coming down the tracks from outside the SEC’s incubator.

That other package of suggested regulations was released in October 2010 by the President’s Working Group on Financial Markets (PWG), chaired by Treasury Secretary Timothy F. Geithner. The PWG came up with an additional list of possible rules that include the special purpose bank idea and a long-discussed, highly controversial proposal that money fund share prices be permitted to float as their portfolio securities’ prices changed. It also included the idea of a  private industry facility to which funds having liquidity problems could turn; insurance; and in-kind redemptions (securities instead of cash).

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