As soon as Robert Barone heard rumors that money market funds were in trouble back in 2008, the financial advisor switched his clients’ assets out of prime money market funds and into government-backed money market funds.
Fast forward to 2012, financial advisors may want to examine money market fund assets before investing or transferring, given proposed regulatory reforms that, among other things, would allow the net asset values of money market funds to float based on their portfolio values rather than be guaranteed at $1.
“We didn’t want any of our clients’ money in European banks, which is why we switched to money market funds guaranteed by the U.S. government. As a result, my clients haven’t lost any money,” said Barone. “If prices float, financial advisors will make decisions on the quality of the paper of money market funds.”
The reforms have come, in large part, as a response to events on September 16, 2008. That day America’s oldest money-market mutual fund, Reserve Primary Fund, broke the buck when its shares fell to 97 cents after writing off debt issued by Lehman Brothers, which had declared bankruptcy the day before. Panicked investors subsequently redeemed their holdings en masse.
“The Fed ended up saving money market mutual funds by making so much liquidity available that risky assets were all able to find the cash to pay,” said Barone, who currently has up to $20 million of his $90 million in assets under management invested in government-backed money market funds.
Barone refers to the optional guarantee backed by the Treasury Department’s Exchange Stabilization Fund announced on Friday September 19, 2008, which promised that if a covered fund broke the buck, it would be restored to $1 NAV.
The insurance stabilized the system and put a stop to outflows.
Since then, a new regulatory agency called the Financial Stability Oversight Council (FSOC) has proposed money market fund reforms that the SEC is being asked to implement.
According to the U.S. Treasury Department, FSOC’s proposed reforms include:
• Funds floating their net asset value to reflect actual market value rather than maintaining it at $1 per share.
• Funds maintaining 1 percent of assets as a NAV buffer to absorb day-to-day fluctuations in value. A small amount of a shareholder’s investment would be subject to a delayed redemption and could be lost if the fund suffered losses over the NAV buffer.
• Funds maintaining 3 percent of assets as a buffer to increase their resiliency.
The FSOC is holding a comment period on the reforms that ends January 18. After the comment period closes, FSOC will make a final recommendation to the SEC, which will then have 90 days to implement it or explain in writing why it is not.
“The SEC, by virtue of its institutional expertise and statutory authority, is best positioned to implement reforms to address the risks that MMFs present to the economy,” said Treasury Secretary Timothy Geithner in a prepared statement.
Geithner added that FSOC’s proposal should take into account the concern expressed that reform of money market funds may result in outflows from them to less-regulated parts of the cash-management industry. “Our objective should be to propose reforms to MMFs that protect their stability, without creating a competitive advantage for unregulated cash-management products,” he said.
The SEC declined to elaborate on why its chief Mary Schapiro withdrew a similar proposal for reform in August.
“While we pursue this path, the council and its members should, in parallel, take active steps in the event the SEC is unwilling to act in a timely and effective manner,” said Geithner in September.
In other words, FSOC isn’t taking no for an answer and will be prepared to wage its authority as granted under title I of the Dodd-Frank act.
Meanwhile, the ICI issued a press release explaining its displeasure with the proposed fixes.
“We are disappointed by the proposals featured in the FSOC’s release, which forces money market funds to float their value, capital requirements and daily redemption holdbacks,” said ICI President and CEO Paul Schott Stevens. “If implemented, they will increase risks to the financial system by concentrating assets in a few large institutions or drive assets into alternative products that are far less regulated and transparent than money market funds.”
Barone said if the proposals are implemented, money market funds will have to invest in less risky assets producing lower returns or introduce some sort of capital or parent-company guarantee, leaving less for investors. “Smaller MMFs lacking capital will either close or be merged into larger funds, resulting in less competition and no need to pay out as much,” he said.
Charles Schwab has stepped up with a proposal to apply the reforms to prime money market funds that invest in corporate, government and international securities rather than funds that invest only in state and federal government notes.
Barone says floating rates and higher capital among prime money market funds will bring market discipline to bear, allowing investors to choose how much risk they want to tolerate for the return.
“The new rules should mitigate the moral hazard issue of taxpayers coming to the rescue,” said Barone.