It was way too late to fix the problems that surfaced six years ago — the fact that it took this long and that the rules were adopted by a split vote of commissioners shows how hard real reform is — but the real question is whether it will stop the financial crisis of 2018, 2024 or whenever the next generational catastrophe hits.
If you’re an investor in money-market mutual funds — the focus of the new rules — you most likely won’t notice any change; as a taxpayer, the potential savings if these regulations work could be in the billions of dollars.
Until the market stress-tests the rules, however, all anyone can do is hope and assume potential problems are eased.
Money funds, which hold more than $2.5 trillion in assets, are supposed to be boring, pain-free investments, a safe place to park cash, which the funds invest in short-term debt instruments of the government and/or some companies. Shares are priced at a constant $1; any interest the fund earns that would otherwise raise the price gets shaved off and reinvested to keep the value stable. If the fund were to lose money — a situation that would typically result in the share price dropping — the fund sponsor typically steps in to make sure that the fund does not “break the buck.”
In 2008, the nation’s oldest and largest money fund, Reserve Primary, broke the buck in the wake of the Lehman Brothers bankruptcy. The $64 billion fund was stuck holding $785 million in Lehman paper; the news started a run of investors fleeing money funds, a dangerously destabilizing event for the entire economy.
Investors who stuck with Reserve Primary — and you can include my own mother in that group — ultimately lost about three cents on the dollar. That’s disheartening but not a big deal when you consider that the fund had paid well-above-average returns for years, meaning that most investors (again, my mother included) did better over the entire time they were in the failed Reserve fund than they would have done in an average bank savings account or certificate of deposit.
The rules changes were not so much about looking out for individual consumers as about curtailing global economic chaos; a smoothly functioning money-market system is, effectively, the foundation of the day-to-day markets.
In 2008, the Federal Reserve and the Treasury backstopped money funds, effectively providing the kind of deposit insurance that’s normally reserved only for bank deposits. That’s not a position the authorities ever want to be in again.
The SEC in 2010 adopted rules requiring greater transparency and forcing money funds to invest in more liquid assets with higher credit ratings and shorter maturities. Officials wanted more; the fund industry didn’t.
Fast-forward to last week, when the SEC’s 800-plus pages of new rules finally ended the threat of an event long-past, without guaranteeing that it can’t happen again.
The biggest step taken to prevent future crises is a “floating net asset value” requirement for institutional prime money funds. Instead of trading at a constant $1, if the fund’s underlying assets suffer a loss, it will show up in the share price, which they will now trade out four decimal places. This reduces what’s called “first-mover advantage,” which is why people rushed the exits in 2008, hoping to get out at $1 despite knowing their shares were worth a few pennies less.
“Government” or “retail” money funds — the ones ordinary investors use — aren’t covered by this provision; they’re keeping the stable $1 value.
The change you might see in your accounts, therefore, is “liquidity gates” and redemption fees.
In times of stress – when a fund’s weekly liquidity falls below certain key levels – a fund’s directors have the ability to halt redemption activity for up to 10 days, if that kind of relief is in the best interest of shareholders. The board also can impose a redemption fee of up to 2{92d3d6fd85a76c012ea375328005e518e768e12ace6b1722b71965c2a02ea7ce}.
The reaction to the rules was as expected, with consumer advocates wishing they had somehow gotten more, while the fund companies felt they had done enough in 2010.
“All [regulators] really can do is prevent some of the dominos from falling,” said Peter Crane, president of Crane Data, which tracks the money fund business. “When you have an occurrence like 2008 when a gorilla knocks over the table, it’s questionable whether these changes will really work.”
For the time being, money fund yields are so low — average yields on retail accounts are about 0.02 percent, according to Crane — that investors are looking at roughly zero return while also taking virtually zero risk. Money funds are a convenient parking place for cash; potential troubles won’t surface until interest rates rise.
“We know the rules work for right now,” said Crane. “We’ll find out if they work for what’s next when they see what’s next.”