Until very recently, most people considered money market mutual funds as safe as bank savings accounts. The funds provided a haven for people who wanted a liquid asset with a better return than a savings account generally provides. But last fall, when the financial markets were melting down, there were runs on several money markets mutual funds. If the government hadn't stepped in, things would have gotten ugly.
The Washington Post reports that this is prompting the SEC to propose changes to tighten requirements for money market mutual funds. That seems like a no-brainer. I'm just not sure why such requirements weren't required from the onset.
Here's the Washington Post's description of the SEC's proposed changes:
One proposal would require that funds maintain 5 percent of their assets in cash or bonds that could be sold within a day. That would make it easier for funds to give customers their money back if a rush of redemptions came in. Funds don't need to maintain such a reserve now.
Another proposal may require funds to invest in only the highest-quality bonds, as judged by credit-rating firms that assess the safety of investments. As of now, funds can invest in bonds of the highest level and second-highest level of quality.
A third proposal would shorten the maximum maturity of bonds that funds can invest in. Currently, under SEC requirements, the average bond in a fund's portfolio cannot mature in more than 90 days.
I think all of these proposals have something in common: they closely resemble the way bank regulators think about deposits.
The first requirement is almost identical to a bank's reserve requirement. If people want to withdraw cash, then the bank needs to have cash on hand to accommodate that request. The same should apply to money markets.
The second and third proposals are both variations on bank capital risk-weighting. If banks hold risk assets, then those assets don't count as much towards satisfying capital requirements as safe assets like cash or government bonds. The latter two proposals are a roundabout way of forcing money market mutual funds to have less risky assets by requiring only the highest-rated bonds and shorter maturities.
These proposed changes make sense to me precisely because they so closely relate to regulatory requirements banks face to safeguard their deposits. After all, people use money market mutual funds these days in almost the same way they use banks savings accounts. Why shouldn't similar regulatory measures apply to each?
I wonder how much it will end up reducing their yields. Not that you invest in money markets for the killer yield, but 5% cash instead of an investment and a requirement for higher-rated paper both are going to lower the return. We had one money market fund break the buck because, apparently, it brainlessly loaned $800 million to Lehman AFTER the Bear Stearns collapse (something that was possibly fraudulent as well http://online.wsj.com/article/BT-CO-20090505-720562.html) and so we need a handful of additional yield-lowering regulations?
2) is stupid. If both sellers and buyers want everything rated AAA then the rating agencies will rate everything AAA. Giving the ratings agencies de-facto regulatory power to determining which assets funds can hold will corrupt the agencies. For ratings to work there must be demand for both high and low ratings.