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August 11, 2012
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Breaking a Buck, Maybe, but Not Taxpayers’ Backs
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By GRETCHEN MORGENSON
MARK Aug. 29 on your calendar. It’s the day all of us could end up on the hook for a big future bailout.
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The Securities and Exchange Commission is expected to vote that day on a proposal that would limit taxpayers’ exposure to the $2.6 trillion world of money market mutual funds. The plan would reduce the odds of having to rescue teetering funds when the next financial crisis comes — and it will.
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Money market funds are a huge cog in the nation’s financial machinery. Many people think that these funds are as safe as federally insured bank deposits. In most cases, they aren’t. But then, in the dark days of 2008, a run on one fund, Reserve Primary, reverberated in the industry.
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Investors fled, and the Treasury stepped in. It earmarked $50 billion to protect money market funds and to prevent them from “breaking the buck,” or having their shares fall below the sacrosanct $1 net asset value. Of course, if the government rides to the rescue once, the thinking goes, it will surely do so again.
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But the S.E.C. has a plan to make money market funds safer, at least for taxpayers. It has proposed that funds set aside enough capital to withstand future runs.
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It has also suggested that funds’ share prices reflect investment reality. Right now, prices are reported daily as $1, regardless of gyrations in funds’ investments.
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A spokesman for Mary Schapiro, chairwoman of the S.E.C., said she is “committed to enhancing structural safeguards of money market funds so that investors are better protected and future taxpayer bailouts can be avoided.”
Not surprisingly, the fund industry sees it differently. Capital requirements would be costly and drive investors away, fund backers say. Letting share prices fluctuate would also cause investors to flee, seeking more stable instruments.
Testifying before Congress in June, Paul Schott Stevens, the head of the Investment Company Institute, the fund industry’s lobbying group, said regulators were making a mistake — that they were viewing money market funds through the lens of 2008. He also noted that while the banking sector encountered multiple and large failures during the turmoil, only one money fund failed to return a $1 share price to investors.
But five years after the financial crisis erupted, it’s hard to see why investors and regulators wouldn’t consider how any part of the financial system held up to the extreme stress of that period. And it is worth asking whether other money market funds might have broken the buck if the government hadn’t stepped in.
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DOCUMENTS recently produced by the Treasury in response to a Freedom of Information Act request support this view. The materials indicate that when the insurance program began, market values of more than a dozen money market funds’ portfolios had fallen below $1 a share. The information request was made by Linus Wilson, an assistant finance professor at the B. I. Moody III College of Business Administration at the University of Louisiana, Lafayette.
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Under the terms of the program, money funds paid to participate based on the market values of their portfolios as reported to the government. Those whose market-based net asset values were at least 99.75 cents were asked to pay one basis point, or hundredth of a percentage point, per dollar of insurance every three months, while funds with values of between 99.5 cents and 99.75 cents had to pay 1.5 basis points per dollar. The increased insurance cost reflected the increased risk that a guarantee might have to be paid to holders of these funds.
If a fund broke the buck and was liquidated, shareholders were supposed to receive $1 a share within 30 days. No fund did, and the program registered no losses over its one-year term. The Treasury received $1.2 billion in premiums from participants.
Last August, Mr. Wilson asked Treasury for a list of program participants and an accounting of the insurance premiums they paid. He received a tally of more than 300 funds last week and, by comparing the premiums they paid to the assets they reported, he determined how many funds had less than $1 in assets for every share outstanding. The funds with 99.5-cent net asset values were those that could have come closest to breaking the buck, he said.
Among the funds reporting values of around 99.5 cents, the five largest had assets totaling $31.5 billion insured under the program, Mr. Wilson calculated. The largest fund in the category was the DWS Money Market Trust, at the time a $12.6 billion fund overseen by Deutsche Bank; it was followed by a Russell Investments money market fund and T. Rowe Price Prime Reserve, both then at $6.4 billion.
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Brian Lewbart, a spokesman for T. Rowe Price, said its fund maintained a $1 share value and never had to tap the program. “Along with other money fund providers, we participated in the program to provide an additional layer of reassurance for our money fund shareholders during a difficult period for credit markets,” he said.
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A spokeswoman for Russell said, “The global financial crisis of 2008 was extraordinary for the industry and we took all steps with an eye toward the interest of our shareholders.” A Deutsche Bank spokesman declined to comment.
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The government’s offer to rescue funds in 2008 opens the door to future bailouts, Mr. Wilson said. “That prospect may lead to careless behavior by sponsors and investors seeking yield,” he added. As a result, he supports the S.E.C.’s idea of requiring that funds maintain a capital cushion.
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FURTHERMORE, even though the government incurred no losses in the temporary program, the premiums it extracted from participants were inadequate for the risks involved, Mr. Wilson said.
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“To break even on the money market guarantee program, the U.S. Treasury needed to charge between 13 and 34 basis points per annum,” he said. “The 4- to 6-basis-point fee was far too low.”
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Yet again, in the heat of the financial crisis, the government granted generous guarantees to private industry far too cheaply. This will always be the tendency when regulators have to put out a financial wildfire. That’s why it is so crucial that the industry — whether a bank or a money-market fund — be required to set aside enough cash before the next crisis hits.
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