Property Rights of Money Market Fund Investors Are Weakened

Here is one more reason (as if one was needed …) why one should hold physical gold outside of the system for insurance purposes. We already briefly alluded to the new rules that are mulled with respect to bond funds, but it seems that they are now implemented for money market funds first.

According to Reuters:


U.S. regulators are expected to adopt rules on Wednesday that force "prime" money market funds used by large institutions to float their share price. Proponents have suggested that moving from the current stable $1 per share net asset value (NAV) to a floating NAV would help prevent investors from getting spooked by the prospect of funds "breaking the buck," or falling lower than that amount.

The Securities and Exchange Commission is also likely to finalize a second provision that will permit fund boards to lower so-called redemption "gates" or charge fees in stressed market conditions, according to people familiar with the matter.

The reform will impact a wide variety of asset managers, from Blackrock Inc, Fidelity and Vanguard to Charles Schwab Corp, Pimco and Federated Investors Inc. The two-pronged reform for the $2.6 trillion industry comes after a long battle between the SEC, the industry and federal banking regulators.

The industry and the U.S. Chamber of Commerce have warned that any rules that drastically change the structure of money market funds could cut off a major supply of short-term funding for corporations. Wednesday's final rule is expected to carve out exemptions for a wide swath of money funds.

Funds used by retail investors, for instance, will still be permitted to maintain a stable $1 per share net asset value because they are considered less likely than institutional investors to run on a fund if the market deteriorates. The U.S. Treasury Department, which has been working to devise a way to relieve investors in funds with a floating NAV from burdensome tax rules, is also expected to unveil its plan sometime on Wednesday, several people familiar with the matter said.

The Financial Stability Oversight Council, a panel of regulators charged with policing for risks, has been pressuring the SEC to bolster money market fund regulations since 2012.

In 2008, the Reserve Primary Fund's heavy exposure to Lehman Brothers led panicked investors to yank out their money, causing the fund to break the buck when its net asset value fell below $1 per share.

The Federal Reserve was ultimately forced to backstop the industry until the chaos subsided. Former SEC Chair Mary Schapiro initially pushed two potential plans for money funds, including either a floating NAV or a capital buffer requirement.

The majority of the industry and three of the SEC's fellow commissioners, however, rejected the ideas, saying they could kill the product and that more study was needed to justify new rules. After the SEC completed a study and the agency assumed new leadership, sentiment toward a floating NAV softened.

While some funds and industry groups are still opposed to requiring a floating NAV, others say they are fine with it as long as it only applies to prime funds and as long as all of the tax and accounting issues associated with a floating share price are resolved.


(emphasis added)

The floating requirement obviously favors the banking industry over money market funds, as these funds have been used by investors as a cash equivalent, bringing a slightly higher return than could be had from a bank deposit. Once their unit prices begin to float, they will no longer be seen as cash equivalents, so  banks will enjoy an advantage.

This advantage is unfair, because bank deposits are by no means safer. On the contrary, since they are fractionally reserved and the assets “backing” them often have far longer maturities than the short term debt money market funds as a rule invest in, they must be regarded as inherently more risky.

However, the main problem is the proposal to erect “redemption gates”. First of all, the Fed was not “forced” to bail out the industry by backstopping it (note that banks are similarly backstopped by the Fed, and this is apparently not questioned at all). The Fed did of course backstop money market funds, but to argue that it was “forced” to do this is a huge stretch. According to which statute was it forced? Given that the Fed's policies caused the bubble that eventually imploded and created trouble for money market funds in 2008, one could of course well argue that it had some moral responsibility to help them. It goes without saying though that the world would be better off without bubble-blowing central banks, as then no rescue operations of this sort would need to be pondered in the first place.

The adoption of “redemption gates” effectively means that money market fund boards will be able to suspend the property rights of their customers. After all, it is their money, and it should be up to them whether or not they want to “yank it out”. In order to make such redemption gates legally enforceable, they will have to become part of the fine print of money market fund agreements. Once again, this creates a big disadvantage for the money market fund industry in favor of banks, since demand deposits will continue to lack such “redemption gates”, in spite of the fact that banks are de facto unable to actually pay out all demand deposits, or even a large portion of them, “on demand”.

It is an interesting detail that retail customers are to be exempt from this regulation based on the idea that they are basically too addled to react to crisis conditions.



Why are such regulations held to be required at all? Are regulators implying that the system has not been “made safe” by adopting several telephone book-sized tomes of additional regulations?


gateConsider yourself gated when it will be most important to get your money out!

(Image by Rannimi (Pvt) Ltd)



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One Response to ““Redemption Gates” for Money Market Funds”

  • Keith Weiner:

    Pater: You make a number of interesting points. One being the reason to hold gold isn’t to speculate on its price but because it’s not subject to counterparty default nor these new “gates”. The other is that a money market fund is safer than a bank deposit because the fund buys short term bills and the bank deposit may be used to buy long bonds.

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