THE $2.6 TRILLION money market mutual fund industry functions much like commercial banking: Clients can access their funds readily and write checks while earning slightly more interest than they would on an actual bank account. This advantage is due in part to the fact that, unlike banks, money market mutual fund accounts are not federally insured, so the funds do not have to pay premiums. That’s no problem, though, since the funds only invest in safe, plain-vanilla short-term securities.
Or so it seemed until 2008, when the collapse of Lehman Brothers caused the value of one mutual fund to fall below $1 per share, triggering a run on the sector that could be stemmed only by Treasury intervention.
Seared by that experience, the Securities and Exchange Commission (SEC), under Chairman Mary L. Schapiro, has been trying to toughen regulations. In 2010, those efforts bore fruit. New rules, accepted by the industry, tightened quality and liquidity requirements for fund portfolios. Ms. Schapiro, with the support of the Federal Reserve, kept pushing for further structural reform — against stiffening industry opposition. Last week she was forced to run up a white flag, at least for now, acknowledging that she was one vote shy of a three-vote SEC majority.
Her proposed reforms would have addressed the money market funds’ “too big to fail” problem in one of two ways. First, funds could have been required to mark their shares to market, as opposed to being allowed to round them to one dollar as current regulations permit; thus, “breaking the buck” would no longer necessarily trigger a panic. Second, the funds could have been required to hold a capital buffer, while clients looking to cash out would have been subject to a 30-day “holdback” on 3 percent of their investments, so as to discourage runs.
The first idea probably wouldn’t accomplish much in practice; if a fund’s finances got bad enough, institutional investors would still have an incentive to race for the exits. The second suggestion, though, strikes us as promising, and necessary, given that the Dodd-Frank financial reform bill eliminated Treasury’s authority to again bail out the money market funds.
Money market fund operators argue that they are stable, not highly leveraged, and that the 2008 panic was an exception that proves the rule. This argument lost force, however, as Ms. Schapiro and others assembled evidence of past instances in which mutual fund firms had to use their own cash to stem losses.
The mutual funds also protest that tighter regulation will send their risk-averse customers fleeing to commercial banks and their yield-hungry customers to riskier offshore funds. But if that’s how market participants respond to more transparency about the true risks and benefits of investing in money market funds, so be it.
Now that the SEC’s reform efforts have been stymied, the only authority capable of acting may be the Financial Stability Oversight Council, established by Dodd-Frank as a kind of super-regulator of systemic risk. It would be that body’s first major test; it must not fail.