“The purpose of the money fund is to bore the investor into a sound night’s sleep.” So wrote Bruce Bent, the founder of Reserve Primary Fund and father of the money market industry, in 2008 in a letter to the SEC. Two weeks later his firm broke the buck.
The sector has been keeping the regulator awake ever since. In November, SEC chairman Mary Schapiro claimed money funds “exacerbated the financial breakdown” and outlined further reforms.
The industry was not impressed and the war of words escalated last week. A choice between dying “by hanging or by bullet” was how Federated Investors CEO Christopher Donahue described the difference between two suggested new rules — moving from a stable NAV to a floating NAV, and a 30 day hold-back on 3% of any withdrawals.
These changes would force the end of the money fund industry, either by making the funds unworkable or moulding them to resemble banks.
Regulators would do well to remember that it was the collapse of a bank — Lehman Brothers — that caused the Reserve Primary Fund to break the buck, not the other way around.
Money funds allow investors to access daily liquidity at par. This function would no longer be available under the new rules, forcing investor cash into banks and exacerbating the problem of “too big to fail” institutions.
The “shadow” banking system, another regulatory target, is a misnomer when used to describe money funds, which offer greater disclosure on investments than banks do.
The SEC should be credited for its actions in 2008 when, along with the Federal Reserve, a run on the money fund industry was averted through guarantees. New rules introduced in 2010 — including better liquidity requirements, higher credit quality stipulations and shorter maturity limits — should also be commended for achieving the stated aim of better protecting investors.
These measures helped the industry deal with the shocks of 2011: the US debt ceiling debacle, the Eurozone crisis and huge investor withdrawals. As Eurozone institutions went cap in hand for central bank funding, US money funds calmly decreased their exposure to the region’s issuers.
The SEC wants to reduce the industry’s susceptibility to runs. But the funds faced a run in 2011 and proved resilient — why add more levels of regulation to a system that functioned well at a time of stress?
It is worth noting the context of Bruce Bent’s description of money funds as a source of security. Bent argued that money fund managers had been chasing yield in the year leading up to the Lehman default, rather than focusing on maintaining stability and liquidity.
The 2010 rules focused on this problem and the events of 2011 proved the measures to be effective. Short term debt issuers agree — several large corporations have rallied against further changes, arguing that they could hit businesses’ ability to fund short term.
Issuers are happy, investors are happy and the system has stood up to systemic shocks.
The buck did not break this time — it does not need fixing.
