Mary Schapiro, chairman of the Securities and Exchange Commission, is leading a controversial effort to overhaul the regulation of money market mutual funds. I wrote about the three major proposed changes earlier.
A story in a new book by John G. Taft, the CEO of RBC’s wealth management arm in the U.S offers a cautionary tale on why reform is needed in the money market business. (Heidi Moore interviewed Taft for her Reporter’s Notebook: Wall Street’s Lost Moral Center.) The background is that investors expect their money market mutual funds to not “break a buck.” The net asset value of money market mutual funds doesn’t fluctuate like other mutual funds. It stays at $1. It has been the industry pledge.
In Stewardship: Lessons Learned from the Lost Culture of Wall Street, Taft tells of receiving a call on Sept. 16, 2008.
The Reserve Primary Fund — a $62 billion money market mutual fund — had broken the buck. It also indefinitely suspended redemptions of its shares for cash. Reserve Primary Fund owned $785 million of Lehman Brothers commercial paper and the investment bank had declared bankruptcy. RBC Management clients were invested in Reserve Primary Fund. “Our clients assumed their money market fund investments could be converted into cash by the next day,” he writes.
An inconvenience if they couldn’t get access to their money? Hardly, Taft writes:
Now that the Reserve Primary Fund had suspended redemptions of Fund shares for cash, our clients had no access to their cash. This meant, in many cases, that they had no way to settle pending securities purchases and therefore no way to trade their portfolios at a time of historic market volatility. No way to make minimum required distributions from retirement plans. No way to pay property taxes. No way to pay college tuition. It meant bounced checks and, for retirees, interruption of the cash flow distributions they were counting on to pay their day-to-day living expenses.
The panic eased after the Treasury and the Federal Reserve announced that they would backstop money funds. Taft also decided that RBC Management would make clients whole for any losses up to 3 cents a share. It would also lend money to any client in hardship from a cash shortage. It was the right thing to do and good business.
My question is what happens without additional reforms if a bunch of Wall Street leaders decide to abandon their clients during the next crisis?
I like how Sallie Krawcheck, formerly president of global wealth and investment management at Bank of America, put it in a recent column in the Wall Street Journal editorial page. She noted that investor brokerage statements value money funds at 100 cents on the dollar and that the money fund entries are reported in the cash section. Everything emphasizes stability and safety.
From hundreds of conversations I have had with money-fund investors, here is what they generally don’t know (despite — or perhaps because of — being bombarded with pages upon pages of legal disclosures):
They don’t know that, notwithstanding SEC actions since 2008, their funds may not be fully safe. They don’t know that as recently as last summer, the largest money funds averaged 45% of their investments in European bank paper, with one major player at just under 70%. They don’t know that, were the investments to falter, half of the top 10 money-fund providers are not large and presumably well-capitalized banks but instead asset managers that don’t have anything like banks’ capital resources.
Nor do money-fund investors know that the largest money-fund managers have been gaining share in the industry over time, therefore concentrating and potentially heightening the risk of a failure. And they don’t know that, while these firms will likely go to extreme lengths to avoid “breaking the buck,” the $1 net asset value represents an implicit, rather than explicit, guarantee.
What is Schapiro proposing? One idea is to allow the net asset value of money market mutual funds to float like other mutual funds, rather than stay at $1. It’s a good change that reflects — and reinforces — reality. Blackrock, the giant money manager with $208 billion in money-fund assets, has come out and backed that part of the reform package.
The other two changes are requiring money funds to hold a healthy capital buffer against turmoil and to keep 3 percent to 5 percent of an investor’s assets for 30 days before an investor could withdraw all their money from the fund.
My reaction is simply this: You can’t trust the pledge not to break a buck — at least not with your safe money, the money you depend on to be there in tough times.
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