Here's a bit of advice to SEC Chairman Mary Schapiro, who has made it abundantly clear that she intends to make further changes to regulations governing money market funds: Quit while you are ahead.
Ostensibly in an effort to make money funds safer for investors, she seems determined to compel changes that likely would make it more expensive for investors to buy money market funds, thereby reducing their already paltry yields and perhaps forcing many of them out of the business. If their usefulness as a cash management tool is significantly reduced by the changes being considered, there is a risk that investors will turn to vehicles that are far less stable, regulated and transparent.
Rather than regulate money market funds out of business, the Securities and Exchange Commission should continue to monitor the effectiveness of the dramatic rule changes it made in 2010. Those changes, which involved increasing the cash that such funds are required to keep on hand to meet redemptions, and boosting the credit standards for the kinds of securities in which they invest, already have proved more than adequate to assure that money market funds are safe for investors.
Like the rule changes made two years ago, the changes being encouraged by Ms. Schapiro are intended to prevent a panic like the one that occurred amid the 2008 financial meltdown, when the Reserve Primary Fund broke the buck due to its investments in Lehman Brothers Holdings Inc., which became worthless after the firm went bankrupt.
The run on the Reserve Primary Fund triggered massive and unprecedented redemptions at many other money market funds.
In the span of two days, investors redeemed $40 billion from the Reserve Fund, or about two-thirds of the fund's total assets. In the span of one week, they yanked $310 billion from prime money market funds, a figure that represented 14% of the funds' total assets at the time.
The run on the Reserve Primary Fund and other money funds also brought short-term-credit markets to a standstill when the funds curtailed their purchases of commercial paper, which many companies rely on to fund their operations.
The bloodbath finally ended when the federal government intervened and guaranteed investor assets held in money funds.
The SEC should be commended for the comprehensive changes it made to money fund regulation in 2010. Without a doubt, those changes made them safer without compromising their usefulness.
The same can't be said of the proposals now on the table.
One regulation would require the funds to build a cash cushion, ranging from 1% to 3% of assets, to help absorb losses.
The main concern about this proposal is that it could have the unintended consequence of increasing the chances of a run on a fund rather than decreasing it. Investors in a fund whose shares have dipped below the $1 mark may rush to get their money out of the fund before the cushion is exhausted.
Requiring the funds to maintain a cash cushion also would drive up costs and, with interest rates as low as they are now, drive more people to look for yield in higher-risk vehicles.
Another idea on the table is to require funds to have floating rather than stable net asset values.
Although a floating NAV might reduce the chances of a run by making it clear to investors that money funds aren't bank accounts — and therefore don't come with a guarantee against a loss of principal — it also probably would lead to a severe contraction of the industry. Many state and local governments, as well as individual investors and companies that use money funds as a cash management tool, would stop regarding the funds as stable financial vehicles in which cash earmarked for future investments or expenses can reside safely.
Again, money fund investors would be forced to look for alternative
investment vehicles outside of banks.
Money market funds are one of the greatest financial product innovations of our time. Their safety and usefulness should be enhanced, not diminished, by regulation.
The rule changes made by the SEC in 2010, which were tested last summer by the debt crisis in the eurozone, are enough to prevent a repeat of the run on money funds such as the one we saw in 2008.
Let's not allow zeal for the perfect to be the enemy of the good.
