Money market mutual funds are
not banks, but account holders can write checks against their accounts. Account holders are promised that they will
get $1 back for each $1 share that they own.
However, there is no deposit insurance connected with the accounts.
Money market mutual funds can
invest in risky securities and need hold no capital on their balance sheets to
absorb any losses that the fund may experience.
In 2010 the SEC introduced new rules to achieve more stability in the
industry, the most important one being a rule that required fund managers to
hold more assets that could be easily sold so as to be more liquid in the case
there was a significant increase in withdrawals from the funds.
Money market mutual funds
evolved from the 1970s and are part of the shadow banking system.
The attempt to increase
regulations on money market mutual funds is just one effort being made to
regulate the shadow banking system. The
Dodd-Frank bill is, of course, the driving force behind most of these efforts.
The industry fought a hard
battle against Schapiro, and, for the time being, has stemmed the tide of new regulation.
On the industry side, the
argument is that the rules introduced in 2010 have proved sufficient and are
enough to protect the industry from future problems.
The other side argues that
since most money market mutual funds lend to the same borrowers, the industry
is subject to systemic
risk because of the failure of one or more borrowers. The concern over the possibility that
something like this could happen increases the probability that in a time of
financial stress, account holders could get “spooked” and this would cause a
run on these institutions.
Ms. Schapiro had suggested
that the SEC impose one of two possible options. First, let the value of the accounts vary
with the market value of the funds’ holdings.
Or, two, require the funds to hold capital to absorb losses. In other words, she wanted to make these
institutions into something out of the past.
The private-side backup to
the problem of capital is that the “sponsors” of these money market mutual
funds will provide money to the funds should the assets of the funds be
threatened. In fact this is what
happened in the recent financial crisis where, according to the article
referenced above, companies that sponsored money funds had to help the money funds
out: “At least $4.4 billion was provided between 2007 and 2011 to at least 78
funds.”
The question then becomes:
will the sponsors always be there?
Although helping the funds
out would seem to be in the interest of the sponsors over time…no one can
really claim to know the answer to this question.
But, the discussion surrounding this
issue for the money market mutual funds can be extended to almost any area of
the banking industry as well as to the shadow banking industry. Let me just take up another subject for a
minute, the
trading of swaps. We are told that:
“When US regulators, (thanks to the Dodd-Frank Act) led by the Commodity
Futures Trading Commission, move to vote on swap execution rules later this
year, the industry fears an overly prescriptive approach that could push
trading towards that of listed futures or equities. In these largely electronic
markets, trading is more frequent and the size of trades is much smaller than
the notional hundreds of millions transacted in OTC derivatives.”
“In anticipation,
the banks that act as big swap dealers are tackling their cost base, investing
in more technology and adjusting to the prospect of using less leverage, taking
less risk and by extension harvesting smaller bonuses.” These changes will tend to raise costs,
reduce revenues, and change the way that business is done.
However,
the technology in this area is already changing with the leaders being Goldman
Sachs, Morgan Stanley, and UBS. The
resulting model will be more like an exchange-traded model. The instruments traded will be more
homogeneous and, as one analyst stated, “we’ll employ our equity tools and
slice and dice orders, so they’ll become smaller” and traded more rapidly and
will spread to more firms and smaller firms.
That is, financial innovation will adapt to the situation.
This
kind of world, as we have seen, becomes more complex, more interactive, and
moves at faster and faster speeds.
As
I have written many times before, the regulators cannot keep up with this
world, the regulators cannot fully understand what they are dealing with, and
the regulators will not be able to prevent the next…or, any future…financial
crisis.
The
world we are in…and the world we are moving into…cannot be comprehended at this
stage because we cannot predict what the evolution of electronics and
information technology will bring. What
we can say about this future is that the private sector institutions will find
the incentives and invent the ways to get around just about anything that the
regulators want to place in their path.
I
believe that in the case of money market mutual funds, causing these
institutions to either allow their accounts to vary with the market value of
their assets or to impose capital requirements on the institutions will result
in customers moving elsewhere in large numbers to institutions that will
guarantee them the value of their initial deposits or will cause firms to find
another way to do their business because the capital requirements raise the
cost of doing business too much.
If
rules like these are imposed on the industry, then another kind of financial
institution will evolve to provide customers with the account guarantee they
want as homogenously as possible. That
is, as with the potential future of the swap market, financial institutions
will evolve that will employ equity tools to “slice and dice orders” into any
form the customer wants...at the cheapest cost.
The
regulators, in my mind, still don’t understand the environment they are working
within. The modern credit engine can
turn a cash flow into almost anything imaginable. After all, finance is just information. Applying alchemy to the finance system to
make it into something the regulators want, will not work. The regulators must “get real” and accept the
world for what it is. The regulators
must attempt to build processes that help the system adjust and focus less on
outcomes, which cannot be achieved.
The
financial world is changing. Electronics
and information technology is going to allow finance to do things we can’t even
imagine. Efforts by the regulators to
force people and institutions into something that used to exist will not work,
yet, they will keep on trying. Since the
regulators will not change, what we need to do is to look for opportunities
that take advantage of the dislocations that the regulators create and take
advantage of them!