Money Market Funds: To Swim or to Float
Ever since the Reserve Primary Fund “broke the buck” in September 2008, the systemic risk potential of money-market mutual funds (MMFs) has generated enormous interest from around the globe. To “fix” what some have perceived poses serious problems for U.S. financial markets, proposals have ranged from moving MMFs to a floating NAV (net asset value), to creating an industry-funded insurance facility, to subjecting the funds to a new regulatory scheme similar to that applicable to banks. (Please review the options provided in the SEC’s request for public input on the President’s Working Group Report on Money Market Fund Reform. Investors should hope that a realistic diagnosis will lead to an appropriate cure.
The debate was renewed last month when the SEC held a roundtable on MMFs and their propensity for risk. The roundtable featured such notables as former Fed Chairman Paul Volcker; FDIC Chair Sheila Bair; CFTC Chair Gary Gensler; and representatives from the Investment Company Institute, Government Finance Officers Association, AARP, the Bank of England, Fidelity, and J.P Morgan. To say the discussions produced disparate opinions on the relative safety and utility of MMFs as an investment vehicle would be an understatement.
The discussion focused on the issue of whether money-market funds pose a general systemic risk or whether the 2008 “run” was merely a symptom of the wider market meltdown. On the one hand, as one participant noted, bank losses during the last few years “vastly exceeded” losses from money-market funds during the last 40 years. Another countered by noting that fund sponsors nationwide have stepped in 144 times since September 2008 to prevent their NAVs from breaching the $1-per-share barrier.
All of which raised the issue of how to deal with future emergency liquidity needs for these funds. The FDIC’s Bair cautioned that the better approach is not just to accept that a run is going to happen again, but to take actions now to minimize potential systemic risk.
The Bank of England’s Paul Tucker suggested that the current MMF structure is doomed to failure as a consequence of investors’ desire for safety, liquidity, and return, all at the same time. Volcker, the former U.S. central bank chief, expressed uncertainty about what public good money-market funds provide.
Of course, attention has long focused on the MMFs’ special feature of maintaining a stable net asset value of $1 per share and whether retail investors generally are confused as to whether this share price is, even implicitly, guaranteed. The concern for many is that the confusion has increased, rather than decreased, as a result of the government’s decision to guarantee all MMFs to prevent a run. This decision, made in the heat of a crisis, may lead to greater moral hazards in the future as investors assume the government will always step in when MMFs break their bucks.
Industry representatives say such concerns are overblown. Their argument: they and their investors are fully aware of the risks but need the diversification and are willing to pay for a “reasonable market return.”
Change to Floating NAV
The big question is whether MMFs should abandon their stable NAVs in favor of a floating one. Volcker, for one, argued that converting to a floating NAV would probably be a simpler option than retaining a stable NAV and supplementing it by adding safeguards that appear to be needed under the current system. This, he said, would result in more regulation than we’ve bargained for.
Given that he sees MMFs as already “a type of bank,” Volker offered that making it “more of a bank” might be a good thing.
In her concluding remarks, SEC Chair Mary Schapiro questioned whether closing the door on a stable NAV option would actually produce the dire consequences that some predict. Instead, she suggested that such a change may actually increase competition among other funds to offer similar and competitive services to traditional MMFs.
What the roundtable ultimately failed to deliver was consensus on what next steps should be considered. Given the comments from the SEC chair, however, a floating NAV looks all the more likely.