Gretchen Morgenson is very interested in the SEC’s proposal to regulate money market funds. All of us should be.
Many consumers expect to earn interest in money market funds without losing money just as they can in interest-bearing checking accounts. In 2008 when the Reserve Primary Fund “broke the buck” (declined below $1 per share – lost money), people raced to take their money out of all money market funds, not just the Reserve Primary Fund.
Money market funds invest in short-maturity bonds, both “commercial paper” (corporate bonds) and US government bonds. Tax-free money market funds invest in short-term municipal bonds. All bonds have default risk – their issuers might be unable to pay principal and interest. Therefore, all of the funds risk losing money.
Someone must bear that risk. By pegging the share price at $1, fund managers have seemed to promise that shareholders won’t. The run for the exits in 2008 shows that shareholders wanted to believe the message, but knew that the fund managers weren’t really bearing the risk either. The Federal Reserve stepped in to guarantee money-market deposits – taxpayers became the risk bearers.
Now the SEC suggests that money market fund share prices should float, just as other mutual fund share prices do. This would eliminate the implicit guarantee – shareholders would immediately understand that their dollars are at risk. Alternatively, says the SEC proposal, money market funds would have to hold a capital cushion to make up for potential losses.
Mutual fund companies think that both of these are terrible ideas. They argue that shareholders will be less willing to invest in money market funds if they believe they might lose money (share prices could float), and that holding a capital cushion will depress returns, making the funds less attractive to investors.
Both arguments are almost certainly correct. However, both ideas are terrific.
Floating money market fund share prices will cause shareholders to believe they might lose money. Shareholders should believe that. They very well might lose money. Investors should be appropriately cautious with their investments.
Requiring money market funds to hold a capital cushion will depress returns, and will make them less attractive to investors. This step will force money market funds to more accurately represent the net returns available from their underlying bond investments. That is, the net returns will be lower because they will incorporate the bond default risk cost, visible for investors to see.
I can understand that money market fund managers would far rather have taxpayers guarantee principal values to shareholders, and I can understand that shareholders would, too.
However, transferring resources from taxpayers to shareholders (and to mutual fund companies, who will enjoy larger profits from larger money market funds) is not good policy. Shareholders are investors, and investors tend to be wealthier than the average taxpayer.
The bank bailouts of 2008 socialized losses and privatized gains in this very same way. Taxpayers (Main Street) were very unhappy while bankers (Wall Street) were thrilled. How soon we forget.