The Securities and Exchange Commission is supposed to look out for the small investor. So, how did it end up precipitating the collapse, last September, of the entire money market fund (MMF) sector and the need for the U.S. Treasury to step in and guarantee $3.4 trillion in shares?
Take a look at Joe Nocera's outstanding piece, "The Risk in Money Funds," in today's New York Times business section, (normally not a solid source for economic and financial analysis). The massive run on all MMF shares was precipitated by The Reserve Fund's "breaking the buck" (marking down the value of its shares from $1.00) because of its holdings of $785 million in bankrupt Lehman Brothers' commercial paper. The run was aborted by the U.S. Treasury Department's guarantee of the $3.4 trillion in outstanding shares last September.
The SEC Sponsors a Shadow Banking System. Originally, MMFs were not allowed to design and market their shares around a stable $1 @ share net asset value. However, in the late 1970s the investment companies persuaded the SEC to let them follow accounting rules and marketing pitches that permitted them to do so under almost any conditions - and sell them, in effect, as alternatives to bank checking accounts, complete with check writing features - "turbocharged" bank accounts, as Nocera describes them.
In the high interest rate environment of the 1980s, the MMFs prospered mightily. By the 1990s, they had become a parallel banking system, providing billions of dollars of short-term credit in competition with commercial banks. To further confidence in MMFs, the SEC started, with industry support, to mandate investments only with top credit ratings from the likes of Moody's and Standard & Poor's. Then, during the subprime mortgage boom, they plunged, indirectly, into that lending business, too, which the credit rating agencies facilitated with plenty of AAA marks on mortgage-backed securities.
In short, the MMFs had everything but FDIC insurance - and now, as a result of last September, they have demonstrated that Washington will guarantee $1 @ share if another run threatens.
Now What? We can't rewrite history - but we can rewrite regulation so that the true riskiness of MMFs is transparent to investors, and reduce the likelihood of another government bailout. As Nocera points out, the single best way to do that is to undo the SEC regulations that let them price and market their shares under almost any conditions at $1.00. Insist that MMF shares trade the way all other mutual fund shares trade.
Another action to make investors more conscious of risk would be to remove the mandate that MMFs invest only in SEC-defined "eligible" securities, and force fund managers to pay more attention to the creditworthiness of their investments. (S&P gave Lehman Brothers' short-term paper their highest credit rating until the day before that firm declared bankruptcy.)
Real reform of the money market sector means it will not enjoy all of the SEC-bequeathed competitive advantages they have had in the past. But if the agency is more concerned about investor protection than the MMF's market share of deposits v.v. commercial banks and savings institutions, it will take the steps advocated above. Otherwise, we might just as well force the conversion of MMFs into FDIC-insured banks (as Paul Volcker, for example, has advocated).
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