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| Tuesday, February 9, 2010 |
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ANALYSIS
March 2, 2009
Sagging Index no longer reflects what’s going on in the market, some say, Replacements? Google it, to start.
March 2, 2009
Downward price spiral will actually boost the cost of capital for most companies. CFOS, take note.
March 2, 2009
The latest bailout at AIG could be a preview of how the president will deal with Wall Street.
March 2, 2009
No corporate defaults. Big debt offerings. Percolating CP issuance. Things may be looking up in the capital markets.
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February 16, 2009 12:01 AM ET
Volcker envisions dramatic changes to money-market funds (Bloomberg)
Their conclusion, however, is based on a fundamental misunderstanding of money-market funds and the problems they encountered in the wake of the Lehman bankruptcy. Although the SEC needs to supplement the already extensive regulation of these funds, there is no reason they should be outlawed. The proposal was included in a set of recommendations issued by the Group of 30 on January 15, entitled “Financial Reform: A Framework for Financial Stability.” Their recommendations for money-market funds would prohibit the funds’ managers from using amortized cost pricing to maintain a stable net asset value (NAV). Funds that wish to continue offering a stable NAV should be reorganized as special-purpose banks. It would also require money-market funds to “only offer a conservative investment option with modest upside potential at relatively low risk” and would also require that money- market funds “be clearly differentiated from federally insured instruments offered by banks … with no explicit or implicit assurances to investors that funds can be withdrawn on demand at a stable NAV.” The Group of 30 offered these recommendations in response to the “widespread run on money-market mutual funds,” which they claim “has underscored the dangers of institutions with no capital, no supervision, and no safety net ….” The Group has clearly been misinformed about the nature of money-market funds and the run on certain funds that occurred after The Reserve Primary Fund broke the buck. The fact is, money-market funds are already subject to regulatory supervision. Although SEC bashing is in vogue, in this case the criticism is totally unwarranted. The SEC exercises extensive regulatory supervision over money-market funds, more so than any other type of investment company. In fact, the Office of Compliance Inspections and Examinations performed a sweep examination of money-market funds at the end of 2007 and early 2008—before the Bear Stearns failure. The SEC was fully informed of The Reserve Fund’s situation and actively engaged in stemming the run. A lack of regulatory supervision did not contribute to the run on the funds. What’s more, money-market funds are well capitalized. The investment vehicles are funded entirely by equity capital. Money-market funds must maintain at least 90% of their assets in liquid securities so that they can honor redemptions requests within seven days under normal market conditions. During the run, some funds redeemed over half of their outstanding shares without losses to any investors. I doubt any bank cover the withdrawal of half of its deposit base without Federal assistance. Lack of capital did not contribute to the run on the funds. In addition, money-market funds already warn investors about possible losses. Every money-market fund prospectus and advertisement includes the following statement: “An investment in the Fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although the Fund seeks to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in the Fund.” Money-market funds sold in or by banks also must disclose they are not guaranteed by a bank. The institutional investors that led the run knew full well that the funds were not banks. Failure to differentiate money-market funds from banks or to disclose the risk of breaking a dollar did not contribute to the run on the funds. The reality is, money-market funds already meet the Group of 30’s recommendation that such funds be “a conservative investment option with modest upside potential and relatively low risk.” The numbers tell the tale. Ninety-five percent of a money-market fund’s investments must consist of obligations with the highest short-term ratings, and the fund’s average weighted maturity cannot exceed ninety days. In addition, a money-market fund generally cannot invest more than 5% of its assets in any one issuer. Over the last ten years, the average annual return on prime money market funds has averaged just under 4%. High yields and risks did not contribute to the run on the funds. So why did institutional investors start redeeming their money-market fund shares en mass after The Reserve Primary Fund broke a dollar? Part of the answer is that these investors had come to expect advisers to bail out their funds. When The Reserve Primary Fund broke a dollar, they realized that the fund advisers could provide only a limited safety net. This realization led them to panic and redeem shares without regard to actual risks. So how do we prevent future money-market fund panics? The Group of 30 recommends forcing funds into the bank model. The advantages of this model are not self-evident, however. In the 30 years since the SEC granted to the first order permitting money-market funds, two funds have broken a dollar. On the other hand, the FDIC’s website reports 55 bank failures in the past eight years, and the FDIC has lost hundreds of billions paying off depositors of failed banks and S&Ls. In stark contrast, the programs established to support money-market funds and the commercial-paper market are not expected to cost taxpayers a dime. Clearly, regulators should take steps to curtail widespread runs on money-market funds. But the Group of 30’s recommendations represent an overreaction that would force the reintermediation of a $2 trillion dollar commercial paper market, protect banks from their primary source of competition, and deprive investors of the ability to obtain reasonable returns with a high degree of safety and liquidity. There is simply no reason to conclude that money market funds are a “danger” to the financial system. Stephen A. Keen, former general counsel of Federated Investors, is currently a partner at the international law firm Reed Smith LLP.
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