The SEC has proposed making modifications to the way money market funds work after an unsettling episode during the 2008 financial crisis that led the government to provide formal backing to this popular method of parking cash. Investors should be aware of what changes may be on the way.
In September 2008, ironically the nation’s oldest money fund "broke the buck" when its net asset value fell below $1.00 a share after its investment in Lehman Brothers debt soured. The bankruptcy of once mighty Lehman had a far-reaching effect, not only sending the stock market into a tailspin but creating a run on money market funds, as investors weren’t taking any chances that additional disruption might be forthcoming. The federal government stepped in to guarantee $3.5 trillion in money market funds to avoid further damage to confidence in the financial system. But regulators want investors to realize that money market funds don’t carry a government guarantee. The SEC wants investors to know there is some risk, if slight, associated with these funds and that a bailout, if one were ever to become necessary, might not be possible.
One of the ways regulators are trying to move investors away from the perception of an implicitly guaranteed fixed net asset value of $1.00 a share is to move to a floating rate design. In actuality, money market funds fluctuate slightly, along with the value of their holdings. But the daily moves have historically been very small, in hundredths or even thousandths of a penny.
Another proposal is to hold back a certain portion of fund sales for a period of time. For example, 5%, or $250, of a $5,000 transaction might be unavailable for 30 days. This would serve to dampen the effect of widespread redemptions if another run on money market funds were to develop. Having fund companies hold more capital is another proposal.
As one might expect, those in the money fund industry, including Federated Investors (FII), are broadly opposed to any changes that would make money market funds less attractive. The amount held in money market funds has already shrunk by around 25% in recent years as interest rates have fallen drastically. Companies in the space naturally don’t want to lose any more business.
One of the knocks on the floating rate design for money funds’ net asset value is that slight changes in valuation might have to be accounted for by declaring capital gains or losses, which would create a nuisance. Losing the accounting ease that a transparent, fixed $1.00 a share net asset value allows could deter some investors.
Money fund proponents also note that, since money markets began in 1971, there have only been a few cases where individuals lost any cash, and even then losses were limited. But changes are most likely on the way. Regulators view money funds as part of what has been referred to as the ``shadow banking system’’, in competition with banks, but not having the same regulatory requirements or associated costs. Moreover, a cessation in lending by money market funds is seen by some as contributing to the 2008 financial crisis and, more recently, to the problems European banks had in finding financing.
Overall, changes to money market funds meant to drive home the point that they are not insured deposits seem inevitable, given the enhanced regulatory climate. But this is a difficult time to implement new rules that would entail some costs, given weaker profits for fund companies and skimpy returns earned by money fund investors as a result of near-zero interest rates. For their part, investors would like to see the ease and convenience provided by money market funds preserved as much as possible. The money fund industry is working closely with the SEC to make sure the implementation of any new rules goes smoothly. Investors should keep abreast of the developments so that they understand the implications of whatever changes are made.
At the time of this article, the author did not have positions in any of the companies mentioned.