On Wednesday, former Federal Reserve chairman Paul Volcker spoke out in favor of tighter regulation, telling a Senate committee that the $2.6 trillion industry acts pretty much like commercial banks and should be regulated accordingly. “The time has clearly come to harness money market funds in a manner that recognizes both their structural importance in diverting funds from regulated banks and their destabilizing potential,” Mr. Volcker testified.
Not surprisingly, the money market funds are resisting, arguing that the 2008 run was a symptom, not a cause, of systemic instability, since the triggering event was the collapse of Lehman Brothers, attributable to bad mortgage investments. The industry notes that the newly enhanced controls on its already plain-vanilla investments protect against any foreseeable meltdown — and that the costs of additional regulation will send customers fleeing to banks or to even riskier offshore funds. And what’s bad for the funds, the industry says, will also be bad for the state and local governments whose debt the funds buy.
One idea under consideration at the SEC is to make funds disclose the precise per-share value of their investments, just as stock mutual funds do. Under current rules, money market funds may claim a net asset value of $1 per share, as long as it’s actually within a half-penny of that. In theory, a “floating” asset value would prevent runs because “breaking the buck” would be a normal occurrence and not a cause for panic — as it was at the Reserve Primary Fund in September 2008. In practice, though, the proposal would achieve relatively little. If a fund’s finances got bad enough, large institutional investors would still have an incentive to race for the exits.
More promising are proposals for bank-like capital requirements and a 30-day hold on a small percentage of the cash in each account — to discourage sudden, massive redemptions. The question is how to structure the safety net and how much to charge the industry for it. Here, both industry and regulators need to think of creative, market-based approaches. Bruce Tuckman of the Center for Financial Stability has proposed letting money market funds bid for the right to borrow emergency cash from the Federal Reserve, as banks now can.
The lesson of 2008 is that, in extreme circumstances, money market funds pose a systemic risk that the government will seek to alleviate. Congress has ruled out a repeat of the 2008 guarantee program — but bailouts are easier banned in theory than in practice. Given that reality, industry and regulators should cooperate to make assurance double-sure.