What’s this? Obama’s economic adviser and former Fed chairman Paul Volcker wants to regulate money market funds like banks.
Via Bloomberg:
Aug. 25 (Bloomberg) — Paul Volcker, the former Federal Reserve chairman who is an adviser to President Barack Obama, said money-market mutual funds undermine the strength of the U.S. financial system and should be regulated more like banks.
“Banks remain the functioning heart of the financial system, and they are protected and regulated,” Volcker said in a telephone interview last week from his New York office. “To the extent they have competitors that have different ground rules, kind of free-riders in my view, weakens the financial system.”
Now, this isn’t entirely new — Volcker has been going after money market funds for some time – but it does look like calls to regulate the industry are gathering pace. On Sept 15, the President’s Working Group on Financial Markets is set to issue an industry report, commissioned by the Obama administration to consider whether MMFs should be forced to abandon the practice of maintaining a $1 net asset value (NAV), or have to set up emergency liquidity facilities.
The scrutiny comes, of course, after MMF the Reserve Primary Fund broke the buck — or went below its NAV – last September, having suffered losses on unsecured commercial paper it had bought from Lehman. The buck-breaking basically collapsed the commercial paper market, a very important source of short-term funding for businesses, and necessitated Fed intervention. So, it’s not necessarily strange that MMFs have garnered some attention since Lehman’s fall.
Notably, the SEC already proposed some relatively minor alterations in June. MMFs have also already come in for a bit of criticism from people other than Volcker. Here for instance, was JP Morgan’s James Stanley speaking at Davos earlier this year:
The people who brought down Lehman and almost Bear Stearns weren’t the banks, they were the money funds. You have this huge industry with $4 trillion of capital, immediate intraday liquidity to the client who wants it with no capital behind that statement and no insurance behind that statement.
That’s not strictly true. MMFs managed to decrease their holdings of Bear Stearns paper before it collapsed but they didn’t do the same for Lehman Brothers — something which actually exacerbated the impact of the investment bank’s collapse — but you get the basic idea: MMFs are bad, greedy, uninsured, etc.
While we don’t think money market are really one of the villains of the financial crisis, we are not necessarily against a change to the industry.
As we noted once before, part of the reason MMFs have escaped regulation so far is that their holdings were seen to be as safe as cash, and classified as such. The funds carry no FDIC insurance, thus the massive panic when Reserve Primary broke the buck. The Fed even had to set up a temporary government guarantee for MMF investments as part of its intervention in September 2008.
Perhaps more significant than Reserve Primary’s buck-breaking, however, was the closure of Putnam Prime. The fund shuttered on Sept 18, before it even dipped below its NAV, citing “significant redemption pressure” — investors were panicking and they simply pulled their money.
In other words, MMFs are no longer seen as safe, and thus perhaps, should not be treated as such. Change needs to happen.
Ironically, however (and we say this without knowing the details of the government’s proposals) the biggest threat to MMFs remains the fact that they are operating in an extremely low interest rate environment. Yields on MMFs are approaching zero and the fund managers still need to take their fees. The money market fund model is essentially broken.
Pity the MMF managers then — they are in for big change, regulation or no.
Related links:
Money market funds face curbs – FT
The slow road to recovery – FT Alphaville
Cash is, err, king – FT Alphaville
How low rates break the buck – FT Alphaville