Paul Volcker, the former Federal Reserve chairman and an adviser to President Obama, said money market mutual funds undermine the strength of the U.S. financial system and should be regulated more like banks.
"Banks remain the functioning heart of the financial system, and they are protected and regulated," Volcker said in a telephone interview last week. "To the extent they have competitors that have different ground rules, kind of free riders in my view, weakens the financial system."
Money market mutual funds, which first appeared in 1971, have developed into a $3.5 trillion pool of cash outside of the regulated banking industry that provides short-term funding to thousands of companies and financial institutions at rates below conventional loans. Their pivotal role in the economy was highlighted in September when the collapse of the $62.5 billion Reserve Primary Fund sparked a run by investors that in turn froze the commercial paper market and threatened to cut off thousands of borrowers.
"They are an absolutely huge source of cash for high-quality borrowers," Anthony J. Carfang, a partner at Treasury Strategies Inc., a Chicago financial consulting firm, said in an interview. "They're highly efficient and very transparent, reducing the cost of capital."
Money funds are the largest buyer of commercial paper, a type of debt that matures within nine months and is a key source of short-term financing for businesses. The funds held $578.7 billion, or 41%, of outstanding commercial paper as of March 31, according to the most recent data published by the Fed. They are also buyers of bank-issued securities such as certificates of deposit and repurchase agreements.
Commercial banks had $1.46 trillion in outstanding commercial and industrial loans on Aug. 12, according to the Fed.
The annual yield on three-month commercial paper sold by nonfinancial companies was 0.26% for the week that ended Aug. 14, according to the Fed. Carfang estimated companies would pay half a percentage point above the London interbank offered rate, or about 0.92%, if they had to replace three-month commercial paper with bank loans.
Money market funds can provide cheaper financing because they are not bound by regulations such as federal insurance requirements on deposits and reserves on loans that increase costs for banks, Volcker said. The funds, which are overseen by the Securities and Exchange Commission, should submit to the same "regulatory burden" as banks or give up accounting flexibility that lets them maintain a stable $1 share price, a chief attraction to investors, he said.
Volcker has been a vocal advocate of imposing banklike requirements on money funds, to the dismay of asset managers as they wait for the Obama administration to issue new rules for the industry.
His proposals "would eliminate money funds as we know them," Paul Schott Stevens, head of the Investment Company Institute, a mutual fund industry trade group in Washington, said in March.
Money fund managers dodged the possibility of radical change on June 24 when the SEC proposed rules changes largely in line with industry recommendations.
Another hurdle approaches Sept. 15 when the President's Working Group on Financial Markets, a government advisory body, is set to issue a report on the industry. The group was directed by the Obama administration in June to consider whether money market funds should be forced to abandon the practice of maintaining a $1 net asset value or be required to set up "emergency liquidity facilities."
Volcker said he is not involved directly with the President's Working Group and would not speculate on what regulatory proposals may result. "I don't know. I'm sure the money market funds have a very powerful lobbying machine," he said.
Officials of government organizations participating in the working group, including the SEC, the Treasury Department and the Federal Reserve, declined to comment.
Volcker first aired some of his views in January when the Group of Thirty, a nongovernmental research group that he chaired, recommended that funds offering banklike services should be required to reorganize as special-purpose banks "with appropriate prudential regulation and supervision, government insurance and access to central bank lender-of-last-resort facilities."
Volcker, who stood by the recommendations last week, said he had not personally drafted the section on money market funds.
"In my vision of the new financial system, you obviously want to protect banks and have strong banks, and I don't think they should be put at a competitive disadvantage vis-a-vis money market funds," he said.
Stevens and industry executives said money funds have proved to be a safe investment for companies and individuals while providing a reliable source of short-term funding to companies.
"Paul Volcker has a 30-year hatred of money funds and he is woefully behind the times," Eugene F. Maloney, executive vice president at Federated Investors Inc., said in a telephone interview. The Pittsburgh company is the third-largest money fund manager.
Volcker said his main concern stands "apart from the degree to which the funds themselves can create a problem if and when they fail." He said he's not worried by the idea of dismantling the biggest lender to commercial paper borrowers.
"They do funnel money to the commercial paper market, but they are just funneling money that would otherwise go to the banks, and it's the banks' business to make loans to those people," he said.
Volcker is the chairman of the Economic Recovery Advisory Board, which Obama created in February to recommend responses to the economic and financial crises. He was Fed chairman from 1979 to 1987 and has been credited with taming inflation during that period.
