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The S.E.C.’s Proposed Rules For Money Market Funds: What A Joke.
The shadow banking system will not die

Vernon Hill ( about me )
Posted 06/26/2009
bankstocks.com
vhill@bankstocks.com

Many of the problems that have afflicted the financial system over the past two years can be traced directly to abuses in the wild-west world of the (largely unregulated) shadow banking system. Subprime mortgage CDO securitizations, credit defaults swaps, you name it. They all fall outside the purview of state and federal banking regulators. Which is a key reason why those products were able to mutate so quickly into financial versions of IEDs that nearly blew up the entire economy.

People often forget that the mother’s milk that finances a big chunk of the shadow banking system is that vast, unregulated pot of money known as money market funds.

In a very real way, money market funds are the foundation of Wall Street’s worst excesses. They compete directly for bank deposits, yet MMF issuers don’t have to pay for deposit insurance or labor under regulatory severe restrictions. Nor do they have to carry out any crazy social missions, such as Community Reinvestment Act, mandated by Congress.

So MMF issuers are free-riding cowboys. Still, when the current crisis began, the first thing the government did was unconditionally guarantee these funds in order to protect the Morgan Stanleys and Merrill Lynches of the world—the very same unfair competitors that were the source of so much systemic upheaval in the first place!

Now the S.E.C. proposes, in the name of “safety,” several reporting and operating rules for MMFs, all of which figure to be toothless and have little effect on how issuers do business. It’s just another example of Wall Street protecting itself.

There is only one solution: if the money market funds want to offer themselves as an alternative to bank deposits, they need to operate under the same rules that banks do. That means:

- Paying for deposit insurance.

- Accepting the social burdens borne by banks.

- Providing financial transparency similar to banks’.

Financial regulation that doesn’t include oversight of the shadow banking system cannot be effective. Money market funds look like bank deposits, walk like bank deposits--and must be regulated like bank deposits. You bankers that continually whine about unfair competition, this is your chance!

What do you think? Let me know!

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Comment:

Erich Riesenberg Posted On 6/26/2009 2:30:11 PM

Bankstocks is a bunch of whiners. Most money markets have bank lines of credit. Would banks have been able to fund those lines? Have you written anyting about the evil of TARP, or the alpahabet soup of FDIC and Fed guarantee programs? You praise or ignore programs which benefit your investee companies and whine about those which don't.

David Wooten Posted On 6/26/2009 3:39:21 PM

Money market funds should NOT have deposit insurance. They did NOT have deposit insurance until the Fall of 2008 when the FDIC decided to guarantee them to prevent a run after one MMF lost money on Lehman Bros securities. FDIC (and the old FSLIC) deposit insurance encourages lenders to make riskier bets and that includes the commercial banks. During the S&L crisis, only one MMF failed. Its depositors were refunded ALL of their money by the parent financial company and taxpayers lost nothing. FDIC deposit insurance is a bad thing that encourages reckless lending. But the most important reason that the financial gravy train crashed was because the Federal Reserve made too much gravy. Setting interest rates at 1% and keeping them there caused borrowers to borrow more and lenders to seek a higher yield (through leverage). Just get rid of the Fed and there wouldn't be any big bubbles.

David Wooten Posted On 6/26/2009 3:40:29 PM

Money market funds should NOT have deposit insurance. They did NOT have deposit insurance until the Fall of 2008 when the FDIC decided to guarantee them to prevent a run after one MMF lost money on Lehman Bros securities. FDIC (and the old FSLIC) deposit insurance encourages lenders to make riskier bets and that includes the commercial banks. During the S&L crisis, only one MMF failed. Its depositors were refunded ALL of their money by the parent financial company and taxpayers lost nothing. FDIC deposit insurance is a bad thing that encourages reckless lending. But the most important reason that the financial gravy train crashed was because the Federal Reserve made too much gravy. Setting interest rates at 1% and keeping them there caused borrowers to borrow more and lenders to seek a higher yield (through leverage). Just get rid of the Fed and there wouldn't be any big bubbles.

Alfred M. King Posted On 6/26/2009 3:48:25 PM

Let's go back to why MMF got started. The government, in its infinite wisdom, had precluded banks from paying current rates for deposits. Customers saw higher rates being offered elsewhere and the risk of disintermediation was such that the government ultimately had to permit banks to pay interest on most types of deposits. Meanwhile, of course, the MMF flourished because of paying higher rates than banks could pay or were willing to pay. So before you criticize the government too much, remember that it was government over-regulation in the first instance that allowed MMF to exist. I agree that the MMF have perhaps too much 'freedom' from regulation, but are you sure you are arguing in the right direction? Perhaps fewer regulations, strictly enforced for all, would be better. I don't like the internecine squabbling among all the bank regulators and your suggerstion is absolutely guaranteed to exacerbate the situration.

Ken S Posted On 6/26/2009 3:51:10 PM

Writing as someone who worked at a mutual fund company, my perspective is a bit different - as you might expect. Our MMFs and those of other mutual fund companies were NOT covered by the FDIC's insurance program, meaning MMF holders were supposedly at risk. In fact, quite the opposite was true, because MMF managers had to be VERY careful to minimize risk to maintain the sahre price at $1.00 day after day. When a bank knows that someone else - the FDIC - is creating moral hazard by insuring deposits at ridiculously low premiums , the banks have an incentive to take risks which are not prudent, because if/when somehing goes wrong, it is not the bank's owners or shareholders who will pay the price of their failures.

James Peterson Posted On 6/26/2009 4:27:16 PM

Money Market Funds have a much better track record than banks. In the history of MM Funds, there have only been two that have "broke the buck" or in other words, had investment losses for their participants. They provide same day liquidity and competitive return. As far as "transparency" is concerned, MM Funds publish each and every holding. So, they are much more transparent than banks. And to say that they are "free-riding cowboys" is also incorrect. MM Funds are regulated by the SEC under rule 2a(7). Finally, check the holdings of a typical MM Fund and you will find that the vast majority of the holdings are debt obligations of banking institutions or their related ABCP issuers. So infract, MM Funds are an important source of liquidity to the banking system. The author of this article is either uneducated or is providing a rhetorical argument.

Erich Riesenberg Posted On 6/26/2009 6:05:33 PM

Oh, and of course, money market funds participating in this program do pay for it. Sure, it can't possibly be enough to compensate for a government guarantee, but bankstocks is claiming TARP is profitable, so surely any small amount money market funds are paying also makes this program a big profit center, right?

author missed the mark on this one Posted On 6/26/2009 7:00:23 PM

James Peterson is right - Matt has no idea what he's talking about with this rant - from Matt has written here, its pretty apparent he has little knowledge of money markets and I'm not sure why he bothered to write this piece - anyone who can spell 'money market' knows that they are one of the most regulated, if not the most regulated, areas of the mutual fund world the proposed rules aren't entirely new - they are tweaking the existing rule 2a-7 which worked pretty darn well until this 'once-in-a-lifetime' (hopefully) crisis came along - so it took an event that nearly took the entire banking system down to show that the current rules might have some holes in it - thats not too bad

Nils Posted On 6/27/2009 4:27:53 AM

Let me put the issue in a wider context and you will understand that the problem is much deeper and more serious. Question: does anybody think that you can transfer credit risk to any short term investor, among which MMF investors? That is, an investor who who gains, say, 5 basis points extra margin over a period of, say, 30 days. That is a risk premium of ca. 40k on an investment of 1 billion. Of course not, he will stop investing as soon as it becomes apparent that there is some credit risk, now or somewhere far in the future. So how can you then transfer ANY credit risk to ANY short term funded venture? You cannot as credit risk can't disapear whatever risk management systems you have in place. It is simple mathematics. Therefore I think that ALL money market borrowers investing in anything different than risk free assets should be regulated. Otherwise the system will certainly blow up again.

Barney Frank Posted On 6/28/2009 11:36:09 AM

Asking politicians to stop meddling in things they don't understand is equivalent to asking Willie Sutton to stay out of banks.

Joel Whitaker Posted On 6/28/2009 10:55:28 PM

Money market funds shouldn't have deposit insurance, and they shouldn't have had it last year. Money market funds wouldn't exist if banks paid competitive interest rates to their depositors. If Vanguard can pay 0.44% on its Prime Money Market Fund, which has an expense ratio of 0.28% (which means it's getting at least 0.72% on the short-term obligations in which it invests), why can't banks offer depositors at least 0.44% on everyday savings accounts, NOW accounts and all the rest instread of the 0.10% to 0.25%, which seems to be typical. Actually, some FDIC-insured bank accounts do better than money market funds. Emigrantdirect.com, for example, pays 1.55%. Ingdirect.com pays 1.5% (and 1.65% on "Electric Checking") and Unity Bank, in New Jersey, pays savers at least 0.75% as long as a depositor has at least $100 in a savings account -- and on some accounts linked to active checking accounts, it pays 2.35% -- better than money market funds, better than web-savings products, better than almost all banks. It can be done. If more banks followed Unity's lead, BankStocks wouldn't have to whine about how unfair money market funds are. Instead, the investment bankers who sell paper to those money market funds would be whining about how unfair banks are.

Joel Whitaker Posted On 6/28/2009 10:56:05 PM

Money market funds shouldn't have deposit insurance, and they shouldn't have had it last year. Money market funds wouldn't exist if banks paid competitive interest rates to their depositors. If Vanguard can pay 0.44% on its Prime Money Market Fund, which has an expense ratio of 0.28% (which means it's getting at least 0.72% on the short-term obligations in which it invests), why can't banks offer depositors at least 0.44% on everyday savings accounts, NOW accounts and all the rest instread of the 0.10% to 0.25%, which seems to be typical. Actually, some FDIC-insured bank accounts do better than money market funds. Emigrantdirect.com, for example, pays 1.55%. Ingdirect.com pays 1.5% (and 1.65% on "Electric Checking") and Unity Bank, in New Jersey, pays savers at least 0.75% as long as a depositor has at least $100 in a savings account -- and on some accounts linked to active checking accounts, it pays 2.35% -- better than money market funds, better than web-savings products, better than almost all banks. It can be done. If more banks followed Unity's lead, BankStocks wouldn't have to whine about how unfair money market funds are. Instead, the investment bankers who sell paper to those money market funds would be whining about how unfair banks are.

mpk Posted On 6/29/2009 4:10:23 PM

I happen to agree with the author. I think the comments miss two important points. First, the collapse of Lehman and the Reserve Fund sparked a run on the MMF industry which nearly crashed the entire system. With an intelligent system of deposit insurance for MMFs, this could have been avoided. Since deposit insurance has pretty much worked as advertised for the conventional banking system for the past 70+ years without undermining capitalism in this country, it shouldn't be that hard to extend it to the MMF industry. Secondly, and I find this truly bizaare. The MMF industry should embrace this idea. Currently, there is only one way for a well established investment management company to blow itself up in short order. That is by screwing up its MMF operation and being forced to support the buck. Go ask Legg Mason stockholders. The truth is that operating a MMF is a stupid business decision for an investment management firm. The fees don't offset the potential enormous liability of maintaining the buck. Why do they do it? When I was a partner of a well known investment management company a dozen years ago I made the same arguments, but no attention was paid. Getting out of the business would have reduced the current income of the management partners. So imagine how "executives" in publicly traded companies act.

John Posted On 6/29/2009 4:10:42 PM

Per the prior comment, banks would have been able to fund lines to MMF if the MMF were within line covenants. Since most MMF would have been facing significant redemptions but for government intervention, most would have defaulted on their covenants and would have been unable to meet margin. So the banks would not have been contractually obligated to continue funding such lines. Would the prior post argue that the banks would have to fund MMF that were in default? With the backing of MMF investments, the government stopped the biggest "bank" run ever (MMF redemptions). Who would have known it, but MMF had government backing all along. The banks were under the misperception that they were competing against a lightly regulated uninsured investment option. The average MMF investor never had a clue or never cared about anything but yield. This post is from a Tarp free community banker. (but in the interests of fairness our bank did elect to offer unlimited insurance under the TLGP just to level the playing field with our MMF friends until someone sorts this disaster out someday)

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