LIBERATING MONEY FUNDS / THE WALL STREET JOURNAL REVIEW & OUTLOOK

REVIEW & OUTLOOK

November 18, 2012, 6:15 p.m. ET

Liberating Money Funds

 

 

• smaller
• Larger

Judging by the long faces on money-market fund lobbyists last week, we're starting to think Washington might reform an industry that received a federal rescue in 2008. On Tuesday, the federal Financial Stability Oversight Council proposed one rule change that would protect taxpayers in the next crisis, plus two others that may not.

The council's "Alternative One" for reform is the best and the simplest: Allow the share prices of money-market mutual funds to float, like the prices of other funds. Since money funds are not insured deposits, investors should understand that they are buying securities that can lose value.




The industry has been allowed to employ a novel accounting technique that lets money funds report a fixed value of $1 a share, even if the underlying assets are worth slightly less. In a crisis, the incentive for investors is to run if they can get out the door with $1 before the fund acknowledges reality.




Reporting market prices is the rule for other kinds of securities and should apply to money funds. With expectations appropriately set, investors have less incentive to run. And politicians will be less likely to see a price decline as a cataclysm requiring an industry-wide guarantee like they provided in 2008.




The council's other two reform options require funds to maintain capital buffers to absorb losses. One option has a tiny capital buffer of 1% but demands that large investors keep 3% of their account "at risk" by imposing a 30-day delay on withdrawals. The other option raises the capital buffer to 3% but lets shareholders drain their accounts at any time.
.

Reuters

U.S. Secretary of the Treasury Timothy Geithner (R-L), Federal Reserve Chairman Ben Bernanke, and Chairman of the Commodity Futures Trading Commission Gary Gensler appear at the meeting of the Financial Stability Oversight Council.

 

 

 

 

These last two options approach bank-style regulation but with less capital than will be required of banks. The customer would continue to receive a confusing message. Is this a security that can lose money or is it really a bank account? Fund managers say that if investors are required to keep a minimum balance "at risk," the product won't have customers. And they say that if a 3% capital buffer is required, the product won't have suppliers, at least not profitable ones.



Not that money-fund execs like floating share prices any better. They fear that customers will flee if they can't treat these accounts as cash with a stable value. But if customers can't accept declining share prices, is this really the product for them? In any case, no business model should depend on an implicit taxpayer bailout guarantee.




Since the industry hates all three options, regulators might as well push the true market reform and liberate share prices.



The council also did a public service by providing a little math to demonstrate that reform won't be the end of the financial world. The industry has suggested dire consequences if reform causes money funds to wither and there is thus less money for Main Street business through the commercial paper market that money funds help finance.




But the council puts the impact in perspective, noting that commercial paper amounts to a mere 1% of domestic debt for nonfinancial companies. Even under a 3% capital buffer, the council estimates an overall increase in funding costs for businesses, households and state and local governments of just 0.0075 percentage points.




This type of analysis was sorely lacking during the 2008 crisis, and it is all the more welcome because it comes from the same regulators who have previously foreseen calamity if markets are allowed to operate without federal support. Whatever the right number is, minute increases in funding costs pale next to the cost of another financial crisis or taxpayer bailout.

Copyright 2012 Dow Jones & Company, Inc. All Rights Reserved