Investors who park their cash in money-market funds expect to be able to withdraw it whenever they want: $1 in, $1 out, plus a tiny gain. Investors who park their cash in money-market funds expect to be able to withdraw
Investors who park their cash in money-market funds expect to be able to withdraw it whenever they want: $1 in, $1 out, plus a tiny gain.
For decades, these funds fixed the value of their shares at exactly $1. That stable price is the No. 1 reason money-market funds are so popular, attracting $2.6 trillion in assets. It gives the impression the shares are as safe as cash.
Despite what many investors believe, however, the $1 share price of money-market mutual funds is not formally guaranteed. If a fund’s investments were to tank, it might not be able to pay the $1 per share that investors have come to expect.
When a money-market’s net asset value falls below $1, it’s known as “breaking the buck,” and it happened in 2008. The value of shares in an industry giant known as the Reserve Primary Fund fell below $1. Its investors rushed to cash out their holdings, and the rush spread to other money-market funds. Investors withdrew more than $200 billion in two days.
The Treasury stepped in to insure money-market holdings, thereby halting the mutual fund equivalent of a bank run. The financial firms that operate the funds also took action, buying troubled securities and contributing additional capital. At least 36 of the 100 largest funds had to be propped up to retain their $1-per-share valuations.
Now the question is what to do. As it stands, money-market investors can expect that Uncle Sam will back their investments — even though the Dodd-Frank financial reform of 2010 tried to close the door on another bailout. When the chips were down, the Treasury rode to the rescue to prevent a systemic crisis. It’s hard to believe the government would stand by next time and let a financial disaster unfold.
This situation has to change. Government has no business guaranteeing private investment returns. Not only is it unfair for taxpayers to bear the risk of losses, but the implicit guarantee creates what’s called “moral hazard” — where money-market managers have an incentive to take bigger risks, knowing they will receive a bailout if their bets go badly wrong.
The Securities and Exchange Commission regulates money-market funds. It spent years developing a plan to solve this problem — a plan so threatening that the money-market industry did everything it could to stop it. In the end, the lobbying worked. On Aug. 22, SEC Chair Mary Schapiro withdrew the proposal. So as of today, in effect, the government is still guaranteeing that it will make investors whole if a money-market fund breaks the buck.
Either the SEC needs to do its job, or another regulator needs to take over. The Federal Reserve would be the best candidate. Doing nothing is not an option.
There is still room for change. Only one part of the SEC reform plan was a deal-killer for the money-market industry.
The centerpiece of the SEC plan was eliminating the fixed $1 share price. SEC staffers reasoned that investors would have a better idea of how their funds were performing if the values of money-market shares were allowed to float, just like the values of other mutual-fund shares. In addition, reducing the emphasis on “the buck” would make breaking below that level less of a shock to the marketplace.
The analysis makes sense. Yet getting rid of “the buck” would cost money-market funds their central selling point. Many of their customers, especially institutions that in some cases are required to park their funds where the money supposedly can’t be lost, would opt instead for traditional bank accounts, or move their money to offshore funds not subject to the restriction. It is probably exaggerating to say that eliminating “the buck” would destroy the money-market business. It surely would hurt it.
SEC staffers also supported another reform that would help to safeguard money-market funds and reduce the risk of moral hazard. They wanted funds to hold more capital, and to prevent investors from withdrawing their money all at once. Those ideas are on the right track. In the course of developing its proposal, however, the SEC watered it down too much. If the money-market mutual fund industry won’t accept a floating share price, then it should be subjected to even stricter capital and withdrawal requirements than the agency ultimately proposed.
Change is necessary, and it must happen before some other company “breaks the buck,” and leaves American taxpayers on the hook for the losses.