One of the most consequential threats the American economy has ever faced arose during the week of Sept. 15, 2008, when the reserve primary fund “broke the buck” as its share price fell below a dollar.
Up until that week, the fund had marketed itself to investors as one of the safest places for Americans to keep their hard-earned money. Yet this “breaking of the buck” panicked large investors into redeeming $40 billion from the fund, forcing the fund to sell tens of billions of dollars in assets immediately. This fire sale in turn depressed asset values, further weakening the fund. This investor run in this one fund quickly became generalized and spread to much of the MMF industry. Investors quickly withdrew approximately $310 billion (or 15% of the $3.7 trillion industry) from prime money market mutual funds.
The dramatic run on the reserve primary fund stopped only after the Treasury Department established the Temporary Guarantee Program to guarantee money market funds. This backstopped the entire $3.7 trillion industry, putting taxpayers on the hook for any losses. This was the single largest taxpayer-backed rescue program during the 2008 crisis and the largest the financial industry has ever received.
In response to the events of September 2008, federal regulators — after a deliberative rulemaking process — implemented much needed reforms to reduce the risk of such catastrophic runs in the future. Specifically, in 2014, the Securities and Exchange Commission finalized a rule requiring certain large MMFs to calculate their share price, the net asset value, so that it “floats,” accurately reflecting its true market value, not the artificially fixed amount of one dollar. The SEC also gave funds additional tools for mitigating run risk, including the authority to impose fees on those seeking to redeem quickly in times of stress and even the authority to halt redemptions entirely for a period of time (so-called gates and fees).
While some are still actively pushing to repeal or substantially weaken these critically important reforms, the good news is that industry’s main trade group just announced its opposition to these repeal efforts. It is worth recalling the importance of these reforms, and the need to maintain them.
The 2008 breaking-the-buck episode proved that MMFs are susceptible to runs and, when they do occur, the financial system can experience major disruptions that cripple the short-term credit markets and the overall flow of credit to the economy. MMFs do not come with reliable capital buffers or government backstops, unlike bank accounts insured by the Federal Deposit Insurance Corp., which can prevent or mitigate the effect of a run. They often rely on discretionary infusions from sponsors to make up for shortfalls. Compounding the resulting fragility, MMFs are also highly interconnected with other financial institutions, the payment systems and the economy as a whole because they are widely used by individuals, institutions, businesses, and state and local governments as cash management vehicles or as sources of credit. And finally, in times of stress, sophisticated and vigilant investors are the first to flee the fund (the so-called first-mover advantage), exposing the less-alert investors to greater risk of loss.
The SEC’s reforms aimed to solve these issues. First, investors would no longer think that MMFs were like a stable bank checking account that can’t lose money. Instead, they would see that these are indeed investment products that go up and down in value on a daily basis. Investors accustomed to seeing share prices fluctuate are less likely to panic when the prices fluctuate. Second, investors will have little incentive to pull their money out (i.e., run) during times of stress, since they will no longer be able to liquidate at an artificially inflated price. And those who decide to exit the fund hastily will pay a fee, thus taking away the incentive to be a first mover and ensuring that those who remain in the fund are not subsidizing the early runner’s exit when a market is declining or volatility is high.
These (and other) SEC actions, taken together, are better protecting investors, markets, the financial system, our economy and taxpayers by requiring the disclosure of accurate market price information and by increasing the transparency of MMF risks. It has also reduced the potential for systemic contagion by taking away the incentive to be a first mover, reducing the likelihood and intensity of future runs, another financial crisis, and the need for more taxpayer-backed bailouts.
But, as mentioned above, some are still seeking to roll back these critical protections, and it is worth rebutting them here. These suggestions — which are opposed by some prominent sponsors of MMFs, including the industry’s main trade group — would replace substantive reforms with certain additional disclosure requirements in fund prospectuses or sales literature. However, disclosure alone simply will not eliminate the first-mover advantage born of the artificially fixed NAV. Nor can disclosure alter investors’ inflated and misplaced confidence in the stability of MMFs. In fact, the very same reserve fund that nearly failed catastrophically made similar disclosures in its technical and legal fine-print disclosures, which were often overwhelmed by marketing and promotional language leaving the investors confused at best, and misled at worst.
Furthermore, the money market fund industry has now adapted to the SEC’s rule, institutional investors have also adjusted, and the impact on municipal financing overall has been negligible. The rules have bestowed enormous benefits on the markets, investors and the public at large: greater stability, increased investor confidence, transparency and fairness, and above all, less likelihood of triggering or inflaming another financial crisis.
Fortunately, SEC Chairman Jay Clayton agrees and believes that repealing the floating-NAV approach would be premature. Last week, Better Markets wrote to him, urging him to stay the course. We are also encouraged that the MMF industry at large has decided to support those reforms as well. We hope that others in Washington won’t be shortsighted, and won’t succeed in sacrificing the many benefits of these reforms to appease a small but vocal segment of the financial services industry.