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It is irritating enough here in the US to have to pay $2 or more to get money out of a cash machine, if there happens not to be a bank branch handy. Imagine if the machine also told you it will not give you the cash for 10 days.
These aggravations – fees and withdrawal restrictions – will soon be threatened by money market mutual funds, which millions of American investors use as a kind of higher interest-bearing savings account.
Money market funds (MMFs) are not actually bank accounts, but they do promise to pay exactly $1 back for every $1 put in, even if the value of the underlying portfolio fluctuates a little. Since they often come with cheque books and debit cards, it is a distinction lost on many users.
Last week, the Securities and Exchange Commission approved a slew of new rules covering the $2.6tn MMF industry. After years of controversy and intense lobbying, it was surprising that fund managers reacted with statements of broad support. One potential explanation for the outbreak of peace is that asset managers view the SEC’s decision as advancing a broader agenda, namely to win more discretion for managers over when and how their investors are allowed to pull money out of funds.
The SEC’s thinking will inform forthcoming debates about how to limit systemic risk and prevent runs across the fund management industry. The conclusion it came to in this case might actually have made runs more likely, not less.
Under the new rules, MMFs that hold corporate or municipal government debt will be allowed to charge a fee for withdrawals or even halt them altogether by putting up gates for up to 10 days, should market liquidity dry up or the fund get into trouble.
There is currently about $1.7tn invested in the affected MMFs. A subset of them that is used exclusively by institutional investors (a little under $1tn of the $1.7tn) will also have to end the $1-for-$1 promise, so that what the institution gets back reflects the exact, floating value of the underlying portfolio down to four decimal places.
Redemption fees, gates and floating net asset values are three potential answers to the same thorny problem: how do you make sure that the investors remaining with a fund are not subsidising an investor who withdraws money?
The new SEC rules are trying to prevent a repeat of 2008, when panicking investors pulled hundreds of billions of dollars out of the funds in the space of a few days.
When it was discovered that the oldest MMF, the Reserve Primary Fund, was sitting on losses from Lehman Brothers debt, confidence in the $1-for-$1 promise evaporated. Mass withdrawals forced funds to sell even their safe holdings, threatening to cause even more losses and prompting even more MMF investors to want their money back: a classic “run on the bank” that was only halted when the government stepped in to guarantee all of the money in all of the funds, making it the mother of all bailouts.
Now the debate over MMFs is being repeated across the asset management industry, which stands accused of adding to systemic risks.
In normal times, a fund keeps a pot of cash on hand to pay a departing investor, but in times of stress, when withdrawal requests are pouring in, it might have to dump assets at fire sale prices, hurting the value of the portfolio and affecting the remaining investors. That means everyone has an incentive to be out the door ahead of others, creating the classic conditions for a run.
US Federal Reserve officials have informally discussed the idea of mandating gates for bond funds, because fire sales are particularly ruinous in the illiquid fixed income markets. Meanwhile, BlackRock, the world’s largest asset manager, with $4.6tn under management, is pushing for redemption fees to be more widely allowed, especially on funds that invest in the most illiquid instruments.
The large managers hope that by getting regulators to focus on the causes of runs, they will be less inclined to pursue the idea of regulating whole firms. BlackRock, Fidelity and others are under threat of being designated “systemically important financial institutions” and subject to curbs on their activities.
Giving fund managers discretion to halt redemptions is superficially attractive, especially given the fiduciary duty to protect investors in their funds.
The trouble is that many investors cannot countenance the risk of losing access to their money, and nor should they. It is as frightening an idea to them as the cash machines stopping working.
What will happen? As market stress rises, it becomes more likely that a fund will erect gates, and the incentive to get out kicks in even earlier. This was a warning made by Federal Reserve governors to the SEC last year, which has been ignored.
We may ultimately find that the SEC has increased rather than decreased systemic risk and, more worryingly, opened the intellectual door to further moves in this wrong-headed direction.
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