Money Market Funds in For Some Changes

Written by: Jack Boylan

The SEC has recently announced that they are in the process of altering the gigantic world of money market funds. As many of you probably remember quite well, these funds had a few hiccups during the 2008 derivatives debacle. In typical lightning fast response times the government has decided that, 5 years later, it might be time to take a look at what the problem was. Money market funds currently hold a jaw-dropping $2.6 trillion in assets and even to this day account for about 22% of all mutual funds. Of course, many people don’t think of money markets as a mutual fund as they are set up with the goal of never going down (or up). Instead, they are designed to have a stable value and pay out an interest rate that matches the rate environment of the time. Because of that, many people were surprised when their fund actually decreased in value in 2008. But these funds truly are mutual funds, it’s just that due to their structure that fact is masked a bit:

…He goes on to explain that “a fixed $1 net asset value [the price each share is worth] that never varies, on the one hand, is tied to an ultra-short-term bond fund that does vary, on the other.”

And therein lies the problem. During extreme stress in the economy/markets some of those underlying short-term bonds will be unable to return the principal to the fund. Get enough of those companies in your money market fund and voila, the funds value must decline. There is absolutely nothing illegal, sneaky or otherwise suspect in the money market fund structure, but because of people’s perceptions of the funds, the SEC is looking at some tweaks to the market:

The SEC’s proposal includes two principal alternative reforms that could be adopted alone or in combination. One alternative would require a floating net asset value (NAV) for prime institutional money market funds. The other alternative would allow the use of liquidity fees and redemption gates in times of stress. The proposal also includes additional diversification and disclosure measures that would apply under either alternative.

These seem like very sensible and reserved ideas (a miracle for a government agency!). Institutional investors, are fully aware of how a money market fund operates and were in no way surprised when they “broke the buck” and went down in value in 2008 (and other times). They really are just ultra short bond funds and these guys know it. As there is really no reason for the charade of a constant $1 net asset value (NAV) for these investors, there is no harm in unlinking that idea for the large institutional players. One note to be aware of: when Wall Street refers to “institutions” they often mean pension plans and mutual fund companies. The actual investors in both of those cases are, of course, the regular, or small investor.

The other alternative that the SEC is considering may cause a bit of concern. What they are actually saying is that you may not be able to get your money out at all during a crises. That’s what the words “redemption gates” are referring to. This gate will presumably allow for withdrawals for a fee, but even then it may just allow some of your money to be withdrawn. This does make sense, in that most crises tend to be fairly short-lived and having a brake mechanism may prevent some ill-thought-out selling. Even a pause on redemptions of a few days allows a short-term fund such as a money market to add more and more cash to their coffers as these bonds come due. If everyone needs to get out at once, the fund may have to sell a bond at a loss that would otherwise pay the full amount just days later. However, human nature being what it is, I am concerned that these “gates” may serve to induce a reaction that is the opposite of what is intended. During a crisis, the fact that these “redemption gates” have been closed could have people panicking as their assets become officially frozen. It’s not hard to envision a bit of a storming of the “redemption gates” scenario, where people are scrambling to get in line for the next opening.

Of course, there is no need to get too worked up about something that hasn’t happened yet. These proposals are still in their public comment period, and therefore we still have a couple more months to go (at least) before anything final is decided upon. But keep an eye out for it as it should be interesting. And naturally, we will keep you posted here at PrimeRates as well!


Money Market Funds in For Some Changes

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