I’m not normally the type to plump for more regulation of the financial services industry, but the S.E.C.’s failure to tighten the rules surrounding money market funds has me mystified. Anyone who saw what happened following Lehman Brothers’ collapse understands the risk the funds pose. After Lehman imploded, a fund called the Primary Reserve Fund (which owned a small amount of Lehman paper) broke the buck, which in turn set off a run on the entire $2.7 trillion market. Soon demand for commercial paper (of which money market funds are the primary buyers) fell to basically zero. Companies that fund themselves via CP (General Electric, for one) faced insolvency. The entire financial system was set to collapse. It wasn’t until the federal government stepped in to backstop the market that order was restored.
So this is an industry that can stand tighter oversight. And yet, inexplicably, the S.E.C. can’t bring itself to act. The main proposal the agency was considering was a mandate that funds move away from their current “stable value” standard, wherein the net asset value of a fund’s share by definition equals $1, to a floating NAV, which is how every other kind of open-ended fund works. Under stable value, it’s easy to see why Primary Reserve holders panicked: early redeemers stood to receive 100 cents on the dollar regardless of the value of the fund’s underlying portfolio, while later redeemers would only get whatever was left. Thus a single defaulting sliver of a single portfolio in single fund sent the financial system into a tailspin. That’s crazy.
Besides, the whole notion of a stable-value fund makes no sense. “The asset values already float, but we just hide it,” Vanguard founder Jack Bogle told the A.P. last week. “There is not the kind of safety that people assume there is. . . . Investors are relying on this illusion that the asset value is fixed. We ought to do away with the illusion.” Recall that Vanguard is the largest mutual fund manager and runs $150 billion in money market funds, so Bogle knows what he’s talking about. And he’s right. In the investment world, the notion of “stable value” is a myth—and in this case, a dangerous one.
Nor, for that matter, are money market funds the dazzling financial innovations their boosters make them out to be. The only reason the money fund industry even exists is because of an anomaly in bank regulation from the 1970s. Back in those high-inflation, high-interest rate days, the FDIC had a limit on what banks could pay on savings deposits that was well below the market rate. Money funds were invented simply as a way to circumvent bank regulation and provide savers with higher returns. But the FDIC’s rate cap has long since disappeared. Money funds are merely a vestige of obsolete bank regulation.
The Lehman experience is more evidence than anyone should need that regulation of money funds needs to be dramatically tightened. The main reason the S.E.C. hasn’t moved, from what I can see, is that the agency has been the object of relentless industry lobbying. The industry has a right to have its say, but the S.E.C. needs to look beyond its narrow concerns and act for the sake of the financial system. The status quo isn’t good enough. It needs to be changed.
What do you think? Let me know!