Should money market funds remain regulated as money market funds, with investors taking the risk that at some point they just might not be able to pull out $1 for each $1 they put in?
Or should they be regulated as banks-and have the government guarantee money in the funds be as safe as cash, up to a point?
That is the nub of the question facing the Securities and Exchange Commission, as well as the new Financial Stability Oversight Council, as these federal overseers try to make sure there is not a run on money market funds that rivals what happened in September 2008.
At a roundtable of regulators, industry experts and academics last week at SEC headquarters in Washington, D.C., its chairman, Mary L. Schapiro, made it clear that the status quo will not be enough to stem potential risk to the nation's financial system if there is another run on the $2.7 trillion invested in money market funds, like occurred that year.
"To prevent future runs, more needs to be done to better protect money market funds-and the broader financial system-from the destabilizing risk that can result from a broad money market fund run," Schapiro said. "I think everyone agrees that our country should never again be in the position of having to choose between providing support to private market participants, including money market funds, or risking a breakdown of the broader financial system."
During the credit crisis, in fact, money market funds-for a moment-took on the defining characteristic of bank accounts: Guarantees that account holders' money was safe and that they could take out the entire balance of what was in their accounts, if they so desired.
That promise, akin to the assuredness given by the Federal Deposit Insurance Corporation to money (up to $250,000) kept in bank accounts, was made reality by the creation of the U.S. Treasury's Money Market Fund Guarantee Program. This came immediately after the bankruptcy of investment bank Lehman Brothers, which spurred a run on money market funds.
Roughly $310 billion was pulled out of money market funds in the week of Sept. 15, 2008 when the nation's oldest money market fund, the Reserve Primary Fund, "broke the buck." Having "improvidently" invested in Lehman Brothers assets, as lawyer and former United States Comptroller of the Currency John D. Hawke, Jr. put it, the value of that fund went to 97 cents on the dollar.
At the roundtable, Kathryn Hewitt, treasurer of the Government Finance Officers Association in Harford County, Md., made it clear that the highest priority for her as an investor in money market funds is the stable value of its assets, at $1 a share. A reasonable return on top of that is expected, she said, but the bedrock she counts on is the stable net asset value.
"It's a free put," said Gary Gensler, chairman of the Commodity Futures Trading Commission, a member of the Financial Stability Oversight Council and a roundtable participant. You have the expectation, he said, that you can put $1 into the investment and get $1 back.
Retail and institutional investors, panelists said, have the same expectation: that their investments in money market investments are the same as cash.
But Bill Stouten, senior portfolio manager at Thrivent Financial, said the stable net asset value makes a money market fund prone to a run. That's because the value of the assets actually can only be realized when the asset is sold. Fund sponsors take the risk that the assets will actually be worth the $1 net asset value, at the time the $1 is needed. Investors who suspect or, worse, know that the assets have fallen heavily in value can spark a similar run.
Which a floating net asset value is supposed to solve. But Hawke said the problem remains: Smart investors will be the first to spot and act on falling values of floating price funds, just as well.
Under one tack suggested for reforming the structure of the money market fund business, funds with stable net asset values would be treated as banks-and regulated as such, noted Bob Plaze, associate director, of the SEC's Division of Investment Management.
But Hawke also shot down the notion that regulating money market funds as banks would solve any crisis-induced liquidity problem. Or solvency problem.
He pointed out that the number of bank failures in 2008 (25), 2009 (140), 2010 (157) and 2011 (40) has "vastly outpaced" any failures of money market funds. "So bank regulation doesn't necessarily seem to me to be the optimum answer," he said.
The Investment Company Institute, which represents the money market fund industry, has proposed the creation of a state-chartered bank or trust company that would act as an emergency liquidity facility in the event of a crisis.
The facility would be capitalized through a combination of contributions from prime fund sponsors and ongoing commitment fees from member funds. Additional capacity would be gained from the issuance of time deposits to third parties. Plus, the facility would have access, under the ICI proposal, to the discount window of the Federal Reserve.
Separately, mutual fund giant Fidelity Investments has recommended that money market funds be mandated into putting aside reserves for a rainy day. The reserve would be funded by a holdback of a portion of a fund's income. Asset manager BlackRock has suggested the sponsor or investment manager, not the money market fund itself, be regulated as a special purpose entity (SPE) and be required to hold sufficient capital to withstand shocks.
Schapiro seemed to suggest that the floating of values of shares in money market funds, every day, would actually have the desired result. Because the promise of funds would still be that their contents were as safe as cash, floating the value would force managers to compete to create the most conservative investment vehicle possible, under this construct.
This competition for conservatism would mean that each $1 in a fund would actually have a $1 of assets to back it up, with a very tight band of movement in the underlying value of assets.
Brian Reid, chief economist of the Investment Company Institute, urged caution in altering any of the "critical features" of money market funds that had made them such a popular investment with individuals, corporations and institutional investors.
But Schapiro also suggested that the search for an answer has only started. "It's a false choice we're making," she said, if the only two alternatives under consideration are letting the net asset value float-or turn money market funds into banks.
The search for an answer continues today, also in Washington, D.C.
The Investment Company Institute is hosting its own one-day money market fund summit at the St. Regis Hotel. Scheduled to take part are William McNabb III, chairman and CEO of The Vanguard Group; Travis Barker, chairman of the Institutional Money Market Funds Association in London and a participant in the SEC roundtable; and, Paul Schott Stevens, president & CEO of ICI.