In the wake of the financial meltdown of 2008, an increasingly persistent attack on money market mutual funds is underway. Present and former high government officials, academics, and some editorial writers have joined the fray, each offering their own approach for reengineering the money fund industry.
Common to all is an apparent failure to examine in depth — or, at least, a lack of appreciation for — the enormous disruption that would be caused by any of the various "remedies," or to make a conscientious cost-benefit analysis of the proposed changes — changes that would inevitably threaten the continued viability, availability and utility of this extremely safe, efficient and popular investment vehicle.
The "sky is falling" posture of the critics is based on the singular experience of 2008 when the Reserve Primary Fund "broke the buck" — that is, suffered a drop in its net asset value (NAV) to something less than $1.00 — because of its improvident investments in Lehman Brothers debt — an investment undoubtedly made on the optimistic and erroneous assumption that the government would never let Lehman fail. When Lehman did fail in September 2008 — twenty months into the financial crisis, in the midst of financial chaos of a sort that had not been experienced for many decades, and after the collapse of the subprime, securitization and auction rate markets, and the failure or forced sale of Countrywide, Bear Stearns, IndyMac, FreddieMac, FannieMae, Merrill Lynch and many banks — the Reserve Fund's net asset value dropped to just under $1.00 per share.
Under normal circumstances — and there had only been one prior incident of a fund breaking the buck — this would not be of great consequence. Indeed, the ultimate loss to the fund's shareholders was virtually imperceptible — less than one cent per share. Had money fund shareholders experienced a credit loss of such insignificance under other circumstances, caused by a credit failure involving a less prominent issuer, in a less turbulent environment, the market would almost certainly have ignored it. But in the midst of the financial crisis, when some of our largest institutions had already failed and others were on the brink, with a loss caused by the failure of a major and highly visible investment bank that did not get anticipated government support, many investors in other funds — principally institutional investors — concerned about the potential for their investments being frozen or their funds breaking the buck, redeemed out of money market funds, many moving to purely government funds. As a consequence even very healthy MMFs were faced with significant liquidity pressures.
These pressures were not the result of deterioration of MMF portfolios – they have had an excellent record of creditworthiness. The liquidity crunch was caused by an unusually large volume of redemptions, occasioned by severe uncertainties in a chaotic market, that threatened MMFs with losses as the result of having to liquidate perfectly good assets prior to their maturity in a "fire sale" environment.
Critics now point to this experience as evidencing a need to effect fundamental changes to the structure of MMFs, including such things as abandoning the stable $1.00 per share NAV or requiring a subordinated capital buffer. Some critics who have never been fond of MMFs would do away with them completely or force them into the banking system or bank-like regulation. But these critics seem to have given little or no thought to the consequences. For example, it would be virtually impossible for banks, which themselves are under severe capital pressures and face diminished loan demand support, to raise the new capital needed to support an inflow of trillions of dollars in new deposits. Moreover, since banks, with their higher cost structures, have not been significant providers of short-term credit, businesses and governments that have relied on MMFs for their short-term credit needs would be significantly disadvantaged. Even if they were able to support such an inflow, the pressure on banks that would result to seek higher returns in a time of low loan demand would likely raise their risk profiles.
I agree that a variable NAV for MMFs would make MMF balances less than perfect substitutes for bank deposits, but surely a modicum of a capital requirement (say a leverage-ratio requirement of 1% or 2%) for the MMFs in exchange for retaining a fixed $1.00 value per share should not be a killer for MMFs. That equity backing could even be represented by the equity in an MMF's sponsoring firm.
1.MMMF industry has less overhead and has historically paid higher yields, thus industry has had huge growth last twenty years.
2.THe MMMF is marketed to a mostly unknowing consumer as a safe investment...never had a loss. Same as a bank money market account.
3.The bank money market account is a typical bank liability and is backed by 8% capital should any bank assets lose value.
4.The bank is required to purchase FDIC insurance to secure the money market account and pay annual premiums for said insurance coverage.
5. The SEC allows MMMF's to invest funds( the public is told are safe and secure) into unsecured commercial paper that will, by definition, naturally blow up on every liquidy and credit crisis.
6.Then, we allow non professional, untrained, non underwriters to originate junk paper from the public, via GMAC, strip mall mortgage brokers, crooked car dealers F&I guys; securitize the same and sell such junk to the MMMF's.
7.Then there is a credit crisis (quality) and a liquidity crisis (convert paper to cash) and shadow banking system implodes, including our little MMMF's.THEY (MMMF's)RECEIVE A BAILOUT!!!
8.Our US government and FDIC guaranty the insured bank'scompetitors call MMMF industry. Thats correct, they use the bank insurance fund (BIF) to guaranty the repayment of MMMF's...and this author does not mention taht.
9.No one, including the FDIC, has done the dirty detailed analysis of the total costs associated with having to bail out the MMMF, commercial paper market, the investment banks, ....all of which represent the shadow banking system. Add up that cost and subtract that cost from a MMMF yield.
10. This author says there have been no losses and he is an ex federal treasury employee. What cave did he live in. Without the two or three federal programs unconstitutionally created in the middle of last crisis....the runs on MMMF"s would still be happening in 2011. Just ask Paulson and get all the information sent to the Fed and Treasury during the crisis to see the HUGE DISASTER!
11. LOOK at the junk the MMMF's owned (via disclosure statements in the middle of the crisis. Unsecured commercial paper that the issuer could not pay back; the issuer had few alternatives.
12. Banks pay FDIC insurance premiums for our private FDIC insurance, and the GOVERNMENT AND FDIC go and bailout our competitor MMMF's who takes low cost funding away from us??? Come on! Then , for a short time period, you guaranty the MMMF investors themselves? What lesson did that teach the public about the risk in MMMF's versus bank deposits...???
13. The author is just plain wrong.....and is espousing his employer's position. Do not just believe me; do your own research behind the three programs created overnight, out of thin air, to bailout the entire MMF industry!
14.Finally, do not respond to me about the bailouts of the BIG BROKE Banks, many of whom are still broke. THEY were not banks, they were investment houses...per repeal of Glass Steagal. There were 6000 banks who did not need or receive bailouts..and we paid our money market accounts.....WITHOUT SPECIAL BAILOUT PROGRAMS THE MMMF industry begged Congress for.