When every solution proposed to resolve a problem meets a wall of opposition it's time to question the problem.
That's where we are with money market mutual funds.
Since that scary September day in 2008 when the oldest money fund broke the buck and the federal government rushed in to guarantee $3.5 trillion parked in money funds, policymakers have been searching for the right reforms.
The Securities and Exchange Commission made several moves in January 2010 designed to make the system safer and more liquid. While detailed and definitely the right direction, these reforms were always viewed as simply the first steps on the road to preventing runs that could trigger another bailout.
Policymakers now seem determined to take the next steps.
Treasury Secretary Tim Geithner made it sound like reform was a done deal in a speech last month. "We are putting in place a carefully designed new set of safeguards against risk outside the banking system," he said. "Money market funds will face new requirements designed to limit their vulnerability to runs like the ones that took place in 2008."
Federal Reserve Board Chairman Ben Bernanke agreed more needs to done to rein in the shadow financial system when asked about money funds by Sen. Charles Schumer at a March 1 hearing.
It was clear Bernanke did not want to pick a fight with the New York Democrat, who specifically asked whether it made sense for money funds to use a floating net asset value rather than the current practice of fixing the value at $1 per share.
Bernanke ducked the question by saying such a move was "categorically" opposed by the industry. That's an odd rationale for a regulator, but Bernanke did say he backs further reforms and cited capital requirements as one good option. The Fed chief seemed most supportive of limiting investor redemptions. (Most of these proposals would let investors withdraw just 95% to 97% of their funds right away. Others would impose a fee on investors who cashed out in times of turmoil.) SEC Chairman Mary Schapiro has consistently championed doing more and has talked about everything from the floating NAV to capital to redemption limits. But other SEC commissioners have balked, so Schapiro may need to water down her plans to get them approved for public comment.
The money fund industry, led by the Investment Company Institute, argues the business is safe and sound as is. The group opposes any additional reform, and in particular, abhors the floating NAV, which ICI claims would kill the industry. You can read the arguments here.
But there is no denying a simple fact: the $1 per share price is a fiction. A dollar invested in a money fund will rise and fall in value, depending on the value of the assets backing the investment.
Denying the obvious is a thread that runs through financial services policymaking: the government doesn't stand behind the government-sponsored enterprises; a $2 trillion-asset bank is not too big to fail.
Floating the net asset value makes sense. I'm not arguing against any of the other remedies, but they seem to be suspenders to the belt that is a floating NAV.
It's pretty simple: if you tell an investor the value is fixed at $1 a share then he is not going to expect a loss. If you tell him the value will float with the value of the investments, the investor is going to know he might lose money.
"The reason why this money runs more than other mutual funds is people put their ready cash in it," said Sheila Bair, the former FDIC chair who is now a senior advisor at Pew Charitable Trusts. "They think every dollar of principal and accrued interest is money good, and they can have it anytime they want.
"Once they see it floating, even if it's floating just a little bit, I think you pierce that perception."
Bair has no financial stake in this debate. She isn't representing a company on either side of it. To be honest, I don't know of a corporate interest that supports reform. The companies that sponsor money funds, including commercial banks, don't want expensive new restrictions and the companies that invest in money funds or borrow from them are happy with the status quo.
But with the exception of Jerry Hawke, a brilliant lawyer who counts Federated Investors as a client, the past and present policymakers I've spoken to view money funds as a risk to the financial system that needs curbing.
Esther George, the president and CEO of the Federal Reserve Bank of Kansas City, told me in a Feb. 29 interview that she backs moving to a floating NAV.
"In the public's eye they have become an insured deposit, and that's a problem," she said. The public needs "to know it doesn't have a dollar asset value. I think that has to change."
Even some bankers who wouldn't speak on the record understand the need for reform.
"Any product that is based on an implicit guarantee is probably a bad thing — think Fannie and Freddie," this banker told me. "We are suggesting, by reporting a $1 every day of the year, that there is no principal risk."
If customers know they bear some risk, they will demand a higher return. Likewise, borrowers would face higher costs. The world would survive higher commercial paper rates and investors would navigate the accounting and tax changes that floating the NAV would trigger.
And if money funds lose deposits, maybe that's a good thing for the financial system — and for banks.
"I would love to see this market shrink. This is highly volatile money," Bair said.
"There is a difference between being safe and being short-term."
The financial system seized up in 2008 in part because money funds stopped lending.
"The whole model is to keep their durations very short so they can pull out at a moment's notice. That was a big driver of the liquidity crisis of 2008," Bair said. "So I don't really like this huge reservoir of very short-term money sloshing around the system."
The money fund industry is already shrinking. Total assets peaked in January 2009 at $3.92 trillion. Today, 632 money funds hold $2.645 trillion. The vast majority of the funds — $1.72 trillion — is held by institutional investors, and just under $1 trillion of that is in prime funds.
The low interest rate environment has pushed some smaller companies that couldn't manage the tighter margins out of the business. There are 20% fewer money funds today than in 2008.
Going to a floating NAV would have repercussions, but are they worse than another meltdown? Couldn't the banking industry pick up the slack? Money funds, remember, were created in the 1970s to take advantage of the limits on the interest banks could pay depositors. Commercial paper is a substitute for bank loans.
Money funds "are banks by another name. Why do money market funds exist at all? There is nothing they are doing that banks can't do. Commercial paper is just a substitute for bank loans," said an industry veteran who would only speak anonymously for fear of alienating people in the money fund business. "The whole reason they exist is they cut out a lot of regulatory costs — capital and overhead costs associated with bank regulations like CRA."
Paul Volcker agrees. He's been pounding the table about the regulatory arbitrage that is money funds for years. Last year he said, "I feel the natural and predominant destination for investors that seek secure, stable-value, interest-bearing financial products is the banking system."
Volcker continued: "An important potential additional benefit to the financial system as a result of applying new regulations" to money funds "would be a banking system funded by an increased amount of stable, lower-cost, deposits. This is not an insignificant factor to consider at a time when banking participation will be important to a restructuring of the residential mortgage market."
If Schapiro can't muster the votes at the SEC to get a proposal out for comment, there is another avenue.
Dodd-Frank created the Financial Stability Oversight Council and charged it with identifying risks to the U.S. financial system. The council, led by Geithner, has the power to designate companies as systemically important, which would bring them under the Fed's supervision. The council also may recommend to the Fed higher prudential standards for these companies.
It might be tough to fit floating the NAV under a "prudential standard," but that umbrella does include everything from higher capital to more liquidity to limits on short-term debt. All moves that could make money funds miserable.
In fact, a floating NAV phased in by the SEC might look a whole lot better to money funds than a rule designed by the Fed and the Oversight Council.