Two Cheers for the S.E.C.’s Money Market Reforms

Semi-kudos to the Securities and Exchange Commission for voting last week to reform regulation of money market funds. But only semi-. My big complaint about what the agency has done: its reforms don’t go nearly far enough. Money market funds will still have the potential to trigger a panic in the financial systems the way they did back in 2008.

That panic in 2008 came about, recall, following Lehman Brothers’ bankruptcy filing. An MMF that owned Lehman debt, the Reserve Primary Fund, “broke the buck”—that is, saw its share price fall below $1 per share—after the value of its Lehman paper collapsed. The ensuing panic and run on Reserve Primary (and then on money market funds generally) threatened to render large swaths of corporate America insolvent, as the market for its commercial paper evaporated. The run was only halted when the federal government stepped in to guarantee the assets of the entire money fund industry. In the end, Reserve Primary’s shares still paid out over 98 cents on the dollar, but the damage was done.

So, yes, the industry needed reforming. The most sensible way to do so would be to simply force funds to get rid the $1-per-share-no-matter-what myth altogether. No other kind of investment fund pretends that its shares are worth some pre-determined value at the end of each day. What makes MMFs different? The S.E.C.’s reforms partially address this issue by requiring that at least money funds held by institutions, roughly one third of all funds, float the value of their shares rather than adhering to that dollar-a-share pretense. But why stop there? The fiction needs to be obliterated entirely. The S.E.C. should’ve insisted that all money market funds, those held by individuals as well as those held by institutions, join the real world and value their shares based on market prices. That’s by far the most effective way to reassure investors of funds’ true value. And MMFs would have all the incentive they’d need to invest their holders’ money safely and prudently.

More generally, I’m hard pressed to come up with a rationale for why money market funds should exist in the first place. The industry only came about as a result of a regulatory anomaly: back in the 1970s, banks were barred by Reg Q from paying interest on demand deposits and were capped on what they could pay on savings accounts. As inflation (and interest rates) rose ever higher, businesses and consumers looked for non-bank savings alternatives that would pay them a market rate on their savings. The money market was invented to meet that demand. It’s now a $2.6 trillion industry.

But, again, why do we still need it? Reg Q is long gone. Bank pay rates on their deposits that are highly competitive with what money market funds pay. It’s already obvious that MMFs can be highly destabilizing (to put it mildly) to the financial system. So by all means the feds should be tightening it regulation of them. The S.E.C.’s moves last week are a good start, but don’t go nearly far enough. As far as that goes, it would be okay by me if the government regulated money funds right out of existence.

What do you think? Let me know!