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 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.
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 email@example.com and find more columns at blogs.reuters.com/james-saft)