Money market funds seem like a plain vanilla type of investment, but they played a key role in the 2008 market meltdown. As a result, regulators have twice now taken a swipe at imposing new safety rules to protect investors and the economy.
The second round of rules were passed by the Securities and Exchange Commission on Wednesday.
- Institutional prime money market funds are required to float the net asset value, or NAV, rather than keeping share prices fixed at $1.
- Money market funds can impose a liquidity fee on redemptions if the fund's weekly liquidity falls below the level required by regulations.
- Redemptions may also be suspended temporarily. The SEC calls them redemption "gates."
- Retail money market funds, the types of money market funds most individual investors purchase, will only be subject to liquidity fees and redemption gates. Share prices for retail money market funds will stay fixed at $1.
According to the proposal, the fees and gates could stem redemptions from money market funds during times of duress. In 2008, massive runs on money market funds added fuel to the fire in the shadow banking industry. Asset prices spiraled down as money funds tried to meet redemptions which eventually contributed to the credit market freeze.
For retail investors the fees and gates shouldn't be a factor most of the time -- redemption gates will only come into play "if the fund's weekly liquid assets fall below 30 percent of its total assets -- i.e., unless it comes under potential stress -- and even then, only if the board determines that a fee and/or gate is in the best interests of the fund," according to the final rule from the SEC.
A liquidity fee will kick in when weekly liquid assets fall below 10 percent -- if the board determines it is in the best interests of the fund.
Better Markets, a non-profit organization promoting financial reform, released a press release yesterday applauding the floating NAV imposed on institutional money market funds, but said that the reforms didn't go far enough to make markets safer.
From the press release:
... Requiring a floating NAV for only a minority of money market funds creates a huge loophole. A stable NAV is an SEC-endorsed fiction that creates the belief in a price guarantee. As we saw in 2008, when investors see that their money market funds are losing money (so-called "breaking the buck"), they start withdrawing their money fast and in large amounts. This run quickly destabilizes the entire financial system, causing contagion and requiring government bailouts. A floating rate NAV for all money market funds is required to end this systemic risk.
As well, the gates and redemption fees could be useful but making them voluntary may render them ineffective, the press release said.
Without stronger reforms, the economy could again be toppled by a tumble in the repo market and money market fund industry.
Would you buy money market funds with a floating share price?
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Senior investing reporter Sheyna Steiner is a co-author of "Future Millionaires' Guidebook," an e-book written by Bankrate editors and reporters. It's available at all the major e-book retailers.