It’s time to end the free-ride for money market mutual funds argues Paul Volcker. The current system is an uneven playing field where these funds ride an implicit government guarantee plus get to carry a falsely risk-free perception based on accounting gimmicks.
Bloomberg: Money-market funds can provide cheaper financing because they aren’t bound by regulations such as federal insurance requirements on deposits and reserves on loans that increase costs for banks, Volcker, 81, said. The funds, which are overseen by the U.S. Securities and Exchange Commission, should submit to the same “regulatory burden” as banks or give up accounting flexibility that lets them maintain a stable $1 share price, a chief attraction to investors, he said.
Keep in mind that these funds’ implicit guarantee was made evident when the Treasury was forced to come out and back certain money market mutual funds in September 2008 for fear of an investor panic. This was right after Reserve Primary Fund “broke the buck” and saw it’s NAV drop below $1.
Unlike bond funds that mark holdings at current market prices, money-market funds value their investments according to their expected payoff at maturity, allowing them to maintain a steady $1 NAV, unless a holding defaults. Returns on investments are credited to customers and distributed monthly as cash or new shares.
The stable $1 NAV has served as one of the funds’ main draws for investors that include companies, pension funds and individuals. The $1 share price has also been labelled the greatest weakness for money funds, and a threat to the wider money markets they serve as lenders.
Indeed, money market funds seem to have long played a game similar to that which AAA-rated CDO’s got away with. Many are sold to investors as investmernts with a similar risk-free profile as a bank account, yet with more flexibility and/or better yield.
Unfortunately, money markets aren’t as sexy as other areas of the financial system, so they probably won’t get the needed regulatory overhaul. But the danger still lurks, and we’ll have no good excuse for having done nothing if they blow up again.
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