We’ll be cleaning up from the financial crisis for a long time, something Securities and Exchange Commission Chairman Mary Schapiro made plain with her radical thoughts on how to regulate the common money market mutual fund.
With a total value somewhere north of $2.5 trillion, money market funds are a true behemoth in the investment world. Most people see them as a boring but ultra-safe place to park cash—kind of like a savings account, only with a higher yield. Yet in difficult times, these funds, which carry no federal deposit insurance, can be anything but boring.
Consider the darkest hours of the financial crisis. In September 2008, Lehman Brothers collapsed and one big money market mutual fund that held Lehman’s once stellar short-term debt suffered losses. No one knew what other money market funds might be holding Lehman debt, too, and the prospect of these ultra-safe havens suffering the unthinkable — losses — led to a global run on money fund assets that nearly crashed the banking system.
It wasn’t the first time a money market fund “broke the buck.” But it was by far the most consequential, and three years later the SEC is looking at ways to prevent a replay. The most radical approach: force money market funds to post their actual value each day instead of allowing fund managers to round up or add extremely small amounts here and there to make sure there is never a loss of principal. The vast majority of mutual funds must mark their value to market. Money funds are an exception because the securities they buy are thought to be almost risk free, and for managers the value of stabilizing investors’ principal typically far outweighs the cost of any adjustments. Another idea is to require the funds to establish a reserve pool, ensuring they will have resources to ensure no loss of principal in interesting times, which is the implied promise these funds make.
Regulators likely won’t go for the first option. A money market fund with a floating share price is an altogether different looking product. The stability is what makes them popular. Without that they are just another mutual fund and would wither away.
A required reserve seems more likely. In 2008, the government stepped in to make good on the implied promise of no loss of principal; in an extraordinary move to stem the panic, the feds guaranteed money market assets as though they were bank deposits. It’s not asking too much that this huge industry set up its own reserve. That would almost certainly lead to less generous yields. But the key feature – stable principal value – would remain.
What’s most important about all this is the message: money market mutual funds are not the same as bank deposits. They are investments not covered by federal deposit insurance, and even though their assets are regarded as highly stable and ultra-safe, they can go sour in difficult times. That modest risk is why they are able to pay a modestly higher yield.