I thought that I had a really good proposal for dealing with money market fund problems. And it is good, far better than what the SEC is proposing. My proposal is better because it treats money market funds like ETFs — they are pass-through vehicles, and as such, do not need capital buffers.
And, my proposal is better, because it recognizes that credit events should be rare but acceptable aspects of how money market funds work. Think about it: particularly when short term interest rates are so low, there is no way for interest to cover even the slightest discrepancies versus NAV.
Under my way of doing things, let there be stable net asset values, freedom in investment guidelines, but the possibility of credit events. The present set of restrictions in investing does no one any good, because the problem is not length of maturity or credit quality, but issuer concentration.
But let money market fundholders analyze the tradeoff between yield and risk. Guess what? Short-term bond fund holders have to do the same thing.
Though I would not do it for individuals, in the Stable Value world, there have been “in kind” distributions where when a fund winds up, it distributes assets pro-rata to clients. With individuals, I would create a second fund that absorbs liquidity from the first fund as assets mature, where fundholders could withdraw assets, if desired.
But why are we going after money market funds? When they fail, the cost is pennies on the dollar, and it rarely happens. Why not go after banks? They fail far more frequently, with much larger losses. I say let money market funds fail, and do not increase regulations on them. Rather, let them be like ETFs, and let them be constrained by the prudence of the free markets. What? You can have investment without the possibility of loss? Ridiculous.
Regulate the banks tightly, but let money market funds go free, but advertise that losses are more than possible.
One final note: in certain fixed income businesses, if there is an involuntary wind-up, two solutions for ending equitably are a pro-rata distribution of assets, or letting the portfolio mature, and sending cash with each maturity. With institutional money market funds the first option is possible: in a crisis, just divide the assets and let everyone work it out. But with retail clients, the second option is also possible: send assets as the portfolio matures, with the complicating factor of what to do with a genuine default. In such a case, collective action is usually preferable for winding up, so that might be the last few percent of liquidity that does not get distributed for some time.
Again, I will say, let money markets have the possibility of failure, rather than have extensive schemes to maintain them at par. Unlike banks, money market failure are small and contained. Tell the SEC and the banking regulators to focus on a real problem — bank insolvency.
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