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Money Fund 'Reform' Will Drive Cash to Banks and Help No One

About $3 trillion in customer balances at brokerage firms is not invested in stocks or bonds but sits in money market funds or FDIC-insured sweep accounts.

Despite the run-up in equity markets and a return to something approaching full investment by the general public, these balances (which I estimated from Investment Company Institute data and reports by bank-affiliated broker-dealers) are historically large, reflecting a continued bias toward conservative investing.

Yields are very low for these products but customers accept that in exchange for safety and convenience.

However, impending troubles exist in all these products:

  1. Money market funds may be forced to use floating net asset values and expose customers to risk of loss of principal. The Financial Stability Oversight Council is pushing this change, thinking it would add safety to the money market fund product. The industry argues it will drive customers out of the product in droves.
  2. FDIC-insured sweep accounts are suffering from a lack of banks to accept the deposits that brokerage firms bundle to get customers the FDIC protection and some rate of return. If analysts are correct and money market funds see customers fleeing, those customers will likely land in FDIC sweeps but there will not be sufficient capacity to accommodate them.
  3. Brokerage credit interest programs. All broker-dealers have a product to place uninvested funds in, and before money funds and FDIC sweeps were invented this was the only option for parking cash available to broker-dealer customers. However they pay a very low rate of interest, and require a broker-dealer to have capital to support the product line. Broker-dealers are still recovering from five years of mediocre results, and don't have the capital if there is a flight from money funds and FDIC sweeps into credit interest products.

The likely outcome if floating NAV is enacted will be that a large fraction of the above balances will land in bank deposits in retail form.

Banks, already way long on deposits, will end up paying even lower rates as funds flood in.  

As policy matters go, no loans will be made that would not have otherwise been made given the surplus, so the regulators' pushing money funds out of business in favor of banks accomplishes very little in economic stimulus, but may keep a downward pressure on interest rates.

For example from September 2009 until September 2012 banks' net loans and leases grew by only about $200 billion, but deposits grew by more than $1 trillion, according to Federal Reserve data.

Brokerage firms have spent the last 10 years trying to provide full services including check writing and paying interest on uninvested balances to customers so they can compete with banks. This has been in response to banks trying to steal the investment business from brokerage firms.

If we are supposed to have learned one lesson from the last five years, it should be that banks don't do that great a job of managing anything, let alone mixing lines of business.

As a policy matter, brokerage firms provide diversity and insulate customers from overconcentration of risk in a shrinking number of banks.

We should remember that money market funds were created in the 1980s as a consumer proposition and took hold because they competed with banks and paid much higher yields to customers.

If they cease to exist even when rates allow higher consumer deposit rates, banks won't pay them if they don't have money funds to keep them honest.

The regulators should stand up for the values financial advisors bring to the table and allow competition between banks and broker-dealers to thrive.

Let the money funds stay at a stable NAV and don't give the banks a freebie.

Richard Heitman is the president of Heitman Financial Services Consulting, which helps broker-dealers find partner banks for their FDIC sweep programs. He can be reached at richardhheitman (at)  


(4) Comments



Comments (4)
Requiring a capital cushion for MMMFs does not disadvantage them in any way, it corrects an unfair advantage the MMMF industry has enjoyed. What kind of market value risk will the taxpayer have to assume when interest rates do begin to rise? Even short term investments will be at risk to break the buck. This group is trying to justify their free lunch. Let them pay for the cost of insurance and retain reasonable liquidity, and let's see how that works. And liquidity expectations should be the same for any entity the government feels it has to protect. If they want the guarantee, fine. Pay for it, If they don't want it, disclose it in big, bold print to the customer and let the customer take the financial risk and MMMF industry take the reputatiion risk.
Posted by pdf70101862 | Thursday, February 21 2013 at 4:23PM ET
It is important to understand that government guarantees are backed by human and corporate taxpayers. Allowing the MMF industry to buy insurance only when their funds are underwater clearly harms taxpayers and is a lousy business model for this line of business at the FDIC.
Posted by Edward Kane | Thursday, February 21 2013 at 2:18PM ET
This is a bit of revisionist history. Banks were very much involved in the creation of MMMFs. MMMFs have been both a source of business and a source of competition for banks. Both are welcome if conducted on fair terms. MMMFs should be clearly understood by investors as not having any federal backing, since the sponsors of MMMFs do not pay the $13 billion per year that the banking industry pays to the FDIC for deposit insurance. And as for how well securities investors faired vs. bank depositors during the recent recesssion, that is clearly mixing apples and oranges, but since it was raised by the author, no insured bank depositor lost a penny during the recession, because of the deposit insurance, which insurance, by the way, is heavily paid for by banks in terms of annunal premuims and a heavy supervisory program. Again, apples and oranges, but I did not make the claim that working through a securities broker is a better deal for investors.
Posted by WayneAbernathy | Thursday, February 21 2013 at 12:18PM ET
Your headline is patently false. The destabilizing run on money market funds post the Reserve Fund breaking the buck hurt everyone and required the US government to explicitly guarantee $3 trillion of assets. The run froze the short term lending markets and crippled the US economy. Any solution that prevents a run on money market funds will benefit every taxpayer.
Posted by HA | Thursday, February 21 2013 at 11:02AM ET
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