Paul Volcker clearly wasn’t kidding when he said the most important banking innovation in the last 30 years was the ATM. Although money market funds go back further than that, to the early 1970s, Tall Paul is not so keen about them either. This isn’t the first time he had gone after money funds, and he is not dropping the topic. But it does not appear that Team Obama is backing this idea.
I wonder if his antipathy goes back to his days as Fed chair. Volcker used money supply targets to rein in inflation, but found in 1982 that they were becoming unreliable due to….money market funds.
The logic behind going after money market funds is the blow up of Reserve Fund as a result of the Lehman failure. But of all the areas of finance, money market funds have not exactly been high on the list of problems. Not that my opinion counts for much, but money market funds does not make my top ten list of banking reform areas. By contrast, CDOs blew up in the 1990s and then made an even more impressive reprise this century. Because they have extraordinary leverage, the damage they do is well out of proportion to the size of the market. . Repos are a form of banking, played a big role in cross market transmission during the crisis (haircuts rose sharply) and is much bigger in aggregate than money market funds ($10 trillionish). From Bloomberg:
Paul Volcker, the former Federal Reserve chairman who is an adviser to President Barack Obama, said money-market mutual funds undermine the strength of the U.S. financial system and should be regulated more like banks.
“Banks remain the functioning heart of the financial system, and they are protected and regulated,” Volcker said in a telephone interview last week from his New York office. “To the extent they have competitors that have different ground rules, kind of free-riders in my view, weakens the financial system.”
Money-market mutual funds, which first appeared in 1971, have developed into a $3.5 trillion pool of cash outside of the regulated banking industry that provides short-term funding to thousands of companies and financial institutions at rates below conventional loans. Their pivotal role in the economy was highlighted in September when the collapse of the $62.5 billion Reserve Primary Fund sparked a run by investors that in turn froze the commercial-paper market and threatened to cut off thousands of borrowers.
Needless to say, the industry does not like the sound of this:
His proposals “would eliminate money funds as we know them,” Paul Schott Stevens, head of the Investment Company Institute, a mutual-fund industry trade group in Washington
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"Repos are a form of banking, played a big role in cross market transmission during the crisis (haircuts rose sharply) and is much bigger in aggregate than money market funds ($10 trillionish)."
But the repo market is money market funds. Not entirely, of course – there's plenty of interbank repo and private bank-central bank repo. But money market funds are among the biggest providers of liquidity to banks via repo.
I'm with Tall Paul. There ought to be tighter regulation or reform of money market funds, or a larger interest rate paid by borrowers to lenders.
In "House of Cards" William Cohan (too briefly) recaps the role that two money market funds played in Bear Stearns' collapse:
"For instance, Fidelity Investments, the mutual fund giant based in Boston, had been lending Bear Stearns $6 billion a day, every day. But that week, Fidelity pulled its overnight funding. Federated Investors, another large mutual fund company, based in Pittsburgh, provided Bear with $4.5 billion in overnight funding on Monday, and then nothing the rest of the week. ("House of Cards," p. 33)
The current 7-day yield of Fidelity's Cash Reserves MMF ($138bb in assets) is 0.34%; the YTD return is 0.54%; the expense ratio is 0.39%.
Lenders like Fido & Federated are not getting their shareholders an appropriate return for the risks they absorb.
The "shadow banking system" largely consists of the nexus between money market mutual funds and the commercial paper market. "Shadow" is a misnomer in that it's an arbitrary regulatory distinction. Any institution that accepts deposits and loans them out is a bank. Money market funds are thus banks and should be regulated as such. Volker is spot on. Stevens is also correct in that regulating them as banks would mean their demise since it would be impossible for them to comply with prudential regulations and still offer a higher rate on deposits than banks. This is a good thing.
I agree with Volcker, although I also agree that this is not necessarily high priority, as there are currently significant protections in place.
But bear in mind that money market funds represent a vast pool of money hungry for yield; and that "wherever the corpse is, there will the vultures gather." The SIVs–not much worse than CDOs–were successfully able to tap the money market fund pool, and it was a small mercy that they blew up relatively early, allowing the mess to be cleaned up before the broader market blew up (although MMF sponsors quietly dropped billions of dollars into the MMFs to make up for SIV losses.)
The other area to watch would be repos–Ginger Yellow is correct, the MMFs are deep into the repo market, and in some cases (like Treasury repos) practically *are* the repo market. One area of concern is "other" repos–repurchase agreements backed by unknown collateral, certainly including instruments that do not meet the eligibility for MMFs. The repo is considered eligible based on the short-term credit rating of the counterparty rather than the collateral, but that's small comfort, as top-rated companies (like Lehman) have been going bust in this downturn.
Further regulation is clearly called for, the only question is of urgency.
Ginger Yellow, RTD and Peripheral are all spot on. MMFs (and other "cash-like" cognates including securities-lending cash collateral accounts) ARE the repo market, ARE the ABCP market, WERE the SIV market, WERE the money-market tranche of CDOs, WERE Bear and Lehman's secured/unsecured lenders. The capital structure instability inherent in asset-liability funding gaps that dealers were running was magnified and perpetuated by these short-term players. Often overlooked in "Top 10" lists, short-duration vehicles were directly and (via bank balance sheets & ABCP) indirectly responsible for a large and unstable portion of global super-senior financing.
The regulation of money market funds should be seen as an absolute necessity if the Fed and the Treasury are to have any control over the extension of short term credit and the money supply.
This crisis is about excess credit, both its issuance and its application. Money Market Funds have played a pivotal role in the extension of excessive credit. The extension of that credit was undertaken without adequate regard of inherent risk; consider Bear Stearns.
The recurring problem in all of this is that there exists a huge amount of debt that cannot be serviced. The yield curve is artificially low and savers continue to be penalized. Yet, it is savings that will ultimately lead to a platform for prosperity, debt won't get you there!
In the last 30 years, money market funds have become an increasingly essential cash management tool for millions of investors, both individual and institutional, and a critical source of liquidity for the U.S. money market, providing households and businesses increased access to financing at a lower cost. Today, they play a central role in the U.S. economy. Strengthening the money market and making money market funds more resilient are vital policy goals.
Earlier this year, ICI, the national association for investment companies, released its Report of the Money Market Working Group (http://www.ici.org/pdf/ppr_09_mmwg.pdf)
with recommendations for new regulatory and oversight standards for money market funds. Retaining the basic framework for money market funds while strengthening regulation of these important investment products is key. The Obama Administration recognized the importance of striking this balance in its recent white paper (http://www.financialstability.gov/docs/regs/FinalReport_web.pdf) on financial services regulatory reform. It advised the SEC and the President's Working Group on Financial Markets to carefully consider ways to mitigate any "potential adverse effects of such a stronger regulatory framework,” such as investor flight into less regulated products.
ICI’s money market fund members are implementing the ICI Money Market Working Group’s changes voluntarily until the SEC finalizes its proposed rules to strengthen money market funds. Investors and markets will be best served by reforms that strengthen money market funds, not by measures that would fundamentally alter them and jeopardize this crucial source of financial and cash management. For more information on recent policy developments in this area, visit: http://www.ici.org/mmfs
Thanks for the opportunity to comment — Ianthe Zabel, ICI media relations