|"Money-Market Fund Proposals Cause a stir"
February 2, 2009
When the Group of Thirty issued its proposals for reforming the financial industry last month, most of the focus was on the influential body's recommendations for capital markets. Lost in the shuffle was a plan that would radically change money-market mutual funds.
Tucked into three paragraphs amid an 82-page report was a suggestion that money-market funds should either let their net asset values float freely or convert to "special-purpose banks" -- steps that fund-industry representatives say would effectively kill money-market funds in their current form.
"If the recommendations are implemented, there will be no more money-market funds, period," said Paul Schott Stevens, president and chief executive of the Investment Company Institute, the fund industry's trade group.
The study and its recommendations came from a G30 subgroup: the Working Group on Financial Reform. The chair of the study, Paul Volcker, former Federal Reserve chairman, is slated to appear on Wednesday before the Senate Committee Banking, Housing and Urban Affairs to discuss the plan.
"If money-market funds provide bank-like services, then they should be organized like banks," said Stuart Mackintosh, executive director of the G30, a Washington-based body of well-known international financiers and academics.
Some fund industry executives dispute the premise of the study.
Charlie Morrison, senior vice president and leader of the money-market group at Fidelity Investments, said that in light of how the vast majority of fund firms coped during the market panic last fall, "this is an industry that's in extremely good shape."
Other observers argue that the G30's recommendations are misguided, and that in fact efforts should be directed at making banks more like money-market funds.
"It's an offense to money-market funds to call them any kind of banks," said Mercer Bullard, assistant professor of law at University of Mississippi and founder of consumer group Fund Democracy.
"Banks have lost billions of dollars," he added, "and money-market funds have proved them to be wasteful and inefficient. One IndyMac costs us more than all the money-market fund failures in the past and future combined."
The Federal Depository Insurance Corp. spent $9 billion in its takeover of the failed IndyMac, according to the U.S. Budget Watch Web site.
The right direction
Bullard said proposals from the Group of Thirty "should reflect money-market funds as the best way to provide an insured mattress for Americans' cash."
"There's a lot of uncertainty [in the industry] about whether this is the way to go," said Joan Ohlbaum Swirsky, a lawyer at the firm of Stradley Ronon, and a specialist in money-market fund regulation.
Swirsky questioned whether the approaches suggested by the Group would appeal to investors. If not, they could trigger a fresh run on money-market funds as investors cashed out of the sector.
"We don't want to do anything that depresses the price of money-market securities," she said.
Swirsky added that the proposal for the funds to convert to "special-purpose banks" was unclear. "There's no existing entity that's a special-purpose bank," she said. She also questioned how funds would transition investors if they had change from one type of entity to another.
The G30's Mackintosh said the report had intentionally avoided providing details. "It's not trying to give administrative instruction," he said. "These are high-level recommendations...that identify gaps in the existing [regulatory] structures and how to fix them."
In the introduction to its money-market recommendations, the report suggests money-market funds have "no capital, no supervision, and no safety net [and are] operating as large pools of maturity transformation and liquidity risk."
But the funds are subject to regulation: Rule 2a-7 of the Investment Company Act. The Rule governs the maturity length, credit quality and diversity of debt that money-market funds can hold.
Bullard said he believes that whatever problems money-market funds faced can for the most part be addressed by vigilant regulators.
"The Securities and Exchange Commission has shown that it's not competent to oversee a prudent regulatory model," he said. "The SEC was virtually blind" to the market problems unfolding over the course of last year, he added.
Bullard said that as well as enforcing Rule 2a-7 more vigorously, the SEC should examine top-performing money-market funds to make sure they aren't taking on too much risk to achieve those results. He also said funds should have to file their portfolios with the agency each day, so the SEC can screen their holdings and spot potential trouble.
Fidelity's Morrison said that he'd like to see small changes to Rule 2a-7, including tightening the credit standards and also mandating specific liquidity requirements.
"There were things we learned in the face of some of the challenges" of last fall. He also said that there needs to be renewed emphasis on best practices. Bullard echoed that idea, saying that fund boards should monitor a fund's net asset value to make sure its calculated holdings match market values.
Money-market funds don't have a spotless record. In September, The Reserve's Primary Fund became the first major fund to "break the buck" -- its net asset value falling below the $1 a share benchmark - and in the past year or so several fund sponsors used their own money, or were at least ready to jump in, to shore up their funds.
The ICI has a money-market working group headed by former Vanguard Group CEO Jack Brennan that is mulling reform proposals. Stevens said the group's plan will be published by the end of March.
Bullard said he'd also like to see a government-backed insurance program for money-market funds paid for by the industry that will backstop a fund if its value fell below $1 a share. But, he added, there should be conditions to ensure moral hazard -- for instance, if the fund broke the buck because it contravened Rule 2a-7, the government could reclaim its money.
That would provide enough regulation and also make proposals for floating NAV rates redundant, Bullard said.
Fidelity's Morrison said he doesn't see the need for any change, either insurance or floating fund, to how money-market funds operate, but some industry figures are open to the idea.
Paul Reisz, senior vice president at Pimco, a unit of Allianz (said he could envision prime money-market funds -- which can invest in corporate debt -- pegged to floating NAVs.
"Clients would get some kind of return, but there wouldn't be such pressure on fund firms," he said.
The G30 report argues that money-market funds should change because they "mimic" the activity of banks. But, said Bullard, banks do this inefficiently because they use demand deposits, which could be redeemed at any moment, to make long-term investments.
"Paul Volcker has a history going back to the 1970s of trying to end money-market funds," said ICI's Stevens. "[Money-market funds] aren't in accordance with the traditional bank regulator's view of the way the world works."
"The report is full of strong banking regulator-speak," said Bullard. He said he wished the report had been "a little less disingenuous" about its motives.
While the study has no legislative clout, the member list of the Group of Thirty reads like a Who's Who of finance. As well as Volcker, members include Treasury Secretary Timothy Geithner, Lawrence Summers, director of the National Economic Council and assistant to President Barack Obama for Economic Policy. Stevens said the study was authored by Volcker and he didn't think it reflected either Geithner's or Summer's views.