The controversial push for further reforms to money market funds is dead. On Wednesday, Securities and Exchange Commission, or SEC, Chairwoman Mary Schapiro released a statement announcing the end to her campaign to strengthen the stability of money market funds.
According to the press release, 3 out of the 5 commissioners told Schapiro they would not vote for a staff proposal to strengthen the funds. The move came just a week before the scheduled vote and after months of pressure from Republicans and Democrats in Congress criticizing further reforms.
From the press release:
… because three Commissioners have now stated that they will not support the proposal and that it therefore cannot be published for public comment, there is no longer a need to formally call the matter to a vote at a public Commission meeting. Some Commissioners have instead suggested a concept release. We have been engaging for two and a half years on structural reform of money market funds. A concept release at this point does not advance the discussion. The public needs concrete proposals to react to.
The battle over the fate of money market funds has been a hot topic for months now. To the uninitiated, the rhetoric around further reforms to money market funds may seem a bit heated. I mean, what are they except glorified savings accounts?
They are so much more, in fact. While money market funds do provide investors with low-cost (relatively) high yields, they're part of a symbiotic relationship. Money market funds invest in short-term debt instruments, one of which is called commercial paper.
Commercial paper is issued by corporations as a way of financing day-to-day obligations and short-term cash needs. It's a relatively inexpensive and quick way of obtaining credit for corporations with good credit ratings.
During the financial crisis, these credit markets dried up, and traditional lenders in the commercial paper market became gun-shy. Lehman Brothers crumbled, and the Reserve Primary Fund broke the buck as a result of its loans to the indebted brokerage, though it was not the only money market fund affected.
Fast forward to 2010, when the SEC unveiled new rules to prevent a recurrence of the events of 2008.
The reforms aimed to make money market funds more liquid and required higher quality investments with shorter maturities. As well, managers of money funds were given the ability to suspend redemptions if it looked like there was going to be a run. For more on the reforms that were enacted two years ago, read "Money market funds safer with new rules."
Now two years later, Schapiro has long contended that money market funds are still vulnerable to runs and pose a unique risk within the entire financial system. Before Wednesday's press release, there were some possible proposals for reform.
The most controversial option was scrapping the fixed $1 net asset value, or NAV, in favor of a floating NAV. The actual market value of the investments would be reflected in the price per share, just like in a mutual fund.
According to her testimony on June 21 before the Senate banking committee, Schapiro cited misplaced investor expectations among some of the reasons that a floating NAV would make sense for money funds.
From the transcript of her testimony:
The stable $1.00 share price has fostered an expectation of safety, although money market funds are subject to credit, interest-rate and liquidity risk. Recurrent sponsor support has taught investors to look beyond disclosures that these investments are not guaranteed and can lose value. As a result, when a fund breaks a dollar, investors lose confidence and rush to redeem.
Back in 2008 when the NAV of Reserve Primary dipped to $0.97, other funds also threatened to break the buck, but their sponsors propped them up at the time.
The idea of a floating NAV went over like a lead balloon in the financial industry. Though the price per share of a money market fund would likely not shift very much, it would have dramatically increased the burden on investors at tax time.
And that could have made money market funds much less useful, which would in turn affect the commercial paper market and on down the line.
"To the extent that you do anything in this environment, that raises the cost to people of owning and using money market funds, you're going to significantly decrease the attractiveness of those funds," says Stephen Bainbridge, the William D. Warren Distinguished Professor of Law at the UCLA School of Law in Los Angeles.
"The great advantage of a fixed NAV is that all you have to report is the interest, not capital gains. You don't have to keep detailed records of cost basis and how long you held them. Who wants to calculate the tax you owe if you buy 1,000 shares at $1 and sell them for $1.01? It's ridiculous the amount of extra burden that would come at tax time," he says.
The second option would have been requiring money market funds to keep capital buffer to absorb losses. Investors would have been able to redeem 97 percent of their shares on demand, but "it would require a 30-day holdback of the final 3 percent of a shareholder's investment in a money market fund," Schapiro said in Wednesday's statement.
"I believe these proposals have merit, address the two structural issues identified, and deserved to see the light of day so that we could receive public feedback," the statement read.
What are your feelings on it? Happy that money market funds will be left alone, or do you think they still pose a risk?
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