InvestmentNews Editorials

SEC must go slow on money fund reform

Feb 12, 2012 @ 12:01 am

A week after Federal Reserve Chairman Ben S. Bernanke said that prudent savers could expect no relief from the Fed's low-interest-rate policy until at least 2014, the Securities and Exchange Commission is threatening to make

things even tougher for savers.

The SEC is planning to propose changes to regulations governing money market funds that likely would drive up their costs, reducing the already minimal yields and perhaps putting some of the funds out of business.

Although the regulations are designed to make money funds safer for investors, the SEC must tread carefully because its revised regulations could have unintended consequences.

New rules, for example, could push investors into riskier and inappropriate investments, or they could reduce stock and bond market liquidity. They also could impair the economic recovery by further shrinking demand for the short-term securities of companies seeking credit.

The regulations under consideration are designed to prevent the kind of money fund panic that occurred during the 2008 financial meltdown. During that crisis, the value of shares of the Reserve Primary Fund fell below the sacrosanct $1 level because of its investments in the debt securities of Lehman Brothers Holdings Inc., which became worthless after the firm failed.

The “breaking of the buck” by the Reserve Primary Fund triggered massive redemptions not only of shares of that fund but of many other money funds. The unusual flows led the government to intervene and guarantee money fund assets.

The proposed regulations would affect both investors and money market fund companies.

DEFERRED WITHDRAWALS

One regulation would require the funds to withhold for 30 days 5% of withdrawals by investors who wished to withdraw all their money. This likely would deter investors from putting all their cash reserves into money funds, which were designed to be readily accessible safe places to store excess cash and earn higher returns than the passbook savings accounts offered by banks.

Because money funds often are used to park balances between securities transactions, the regulation could affect stock market liquidity.

The regulations also would require the funds to boost their capital by receiving capital injections from the parent company, issuing stock or debt securities, or charging shareholders higher fees.

The latter two methods would raise costs enough to eliminate the minuscule investment returns that the funds pay, driving investors away.

The result might be a further decline in the number of money funds, which has dropped by almost 40% since 2008.

The proposed regulations follow SEC regulatory changes in 2010 that increased the amount of cash that money funds are required to keep on hand to meet redemptions, and also increased the credit standards for the kinds of securities in which the funds can invest.

These regulations reduced the investment returns that the funds could pay to investors.

The SEC should watch money funds in the wake of the 2008 crisis.

But before rushing to make additional changes that could harm funds, investors and perhaps the economy, the agency should wait to see if the 2010 regulations are a sufficient guarantee of fund safety. Making money funds perfectly safe will reduce their returns to zero and eliminate their value to investors and the economy.

Meanwhile, advisers should examine the likely impact of the regulations on the money fund industry and clients, and make their views known to the SEC. Time is short, as the proposals are expected to be announced in the next few weeks.

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