Bungled Bailout

Treasury pushes for new regulations to solve problem created by previous regulations

The Treasury Department is pushing for a new batch of regulations on money market mutual funds (MMFs) to dispel consumer notions that the funds are backed by a government guarantee—a notion created by a bailout forced on the industry against its wishes in 2008.

MMFs are conservative investment vehicles that rely on interest and short-term lending for profit. Institutional investors use MMFs to diversify their portfolios, while mom-and-pop customers invest in MMFs because they offer better interest than traditional savings accounts.

President Obama’s top financial regulator, SEC Chairwoman Mary Schapiro, is now using the latter group to justify increased regulations that could weaken the $2.7 trillion industry and pump money into big banks or overseas holdings.

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"Most investors treat money market mutual funds like bank accounts—where customers are guaranteed to get at least one dollar back for every dollar they deposit," she told the Society of American Business Editors and Writers (SABEW) Annual Convention in March. "However, these products are, in fact, not bank accounts, but investment vehicles whose value can on occasion slip below or move above a dollar."

The Federal Deposit Insurance Corporation guarantees bank accounts up to $250,000 in the event of an emergency. MMFs, which offer growth rates and flexibility to customers similar to those offered by bank accounts, do not fall under this protection. Schapiro fears that the lack of a guarantee may lead to runs on MMFs and that consumer misconceptions could trick investors into remaining in a sinking fund.

However, the government is responsible for the illusion of a guarantee, according to industry experts.

"During the crisis it was a real mistake for the Treasury to put insurance on money market funds," said Mercatus Center economist Hester Peirce. "It’s harder to argue that there is no bailout because they’ve bailed them out—it’s hard to undo that."

In September 2008, Reserve Primary Fund, the oldest MMF in the country, fell below a $1 net asset value, a rate used to measure stability of the industry, after lending money to Lehman Brothers. The news sent a shock through the market and within two days investors filed redemption requests for $40 billion of the fund’s $62.5 billion assets. Regulators from the Federal Reserve and Treasury Department, already pushing bailouts for major banks, stepped in and placed a guarantee on all assets held in MMFs as of September 19, 2008, to stem the bleeding.

The move angered the industry.

"At that point in time, we did not want the guarantee, but the government had already announced it and we had to go along," said one MMF insider. "We did everything we could to limit its scope and its duration."

The industry was forced to contribute $1.2 billion to the Exchange Stabilization Fund, which guaranteed the MMF holdings. The program ended September 18, 2009; no MMF ever tapped into the fund.

The "Temporary Guarantee Program for Money Market Funds" has been overshadowed by the more prominent bank and auto bailouts that arose following the crisis. This has helped reduce consumer confusion over MMFs and savings accounts.

"People know this is an investment vehicle," said Brian Reid, chief economist for the Investment Company Institute (ICI), the national association of investment companies.

A study conducted by Fidelity Investments, the country’s largest MMF, reached similar conclusions. Fidelity polled more than 5,700 customers and found that 75 percent of investors were aware that MMFs are not guaranteed. About 60 percent of non-professional investors said the government would not intervene to save struggling funds, while only 10 percent believed it would.

"It’s unfortunate that at the time the Reserve Fund failed in 2008, they went straight for a bailout," Peirce said. "Normally, the Senate Banking Committee would have held a hearing, taken a sober look at the issues behind the [fund bankruptcy]…there were real process problems here."

One lawmaker is trying to take such an approach.

Rep. Jo Ann Emerson (R., Mo.) of the House Appropriations Committee has proposed an amendment to a funding bill that would force the SEC to conduct a review to see how effective the agency’s 2010 reforms have been at reducing risk. Those reforms heightened maturity and disclosure requirements and limited MMF holdings to top grade investments.

"She’s asked for a review of that regulation in her bill that will report on whether that has been effective at mitigating risk," Emerson spokesman Jeffrey Connor said.

The Wall Street Journal slammed Emerson in an editorial Monday, accusing her of trying to postpone Schapiro’s proposed reforms with a study. Emerson’s office said the financial paper mischaracterized the nature of the amendment.

"We’re not going to talk about some hypothetical rules; if they actually read the amendment, they’d see that it’s only focused on 2010," Connor said. "There’s nothing in the bill that prevents the SEC from making rules."

The study may not stymie Schapiro’s reform, but a positive review may demonstrate that the markets are already well regulated. A separate Fidelity study submitted to the SEC in March found that MMFs hold more liquid assets than were ever cashed out in the 2008 crisis.

"Money market funds now hold investment portfolios with lower risk and greater transparency, characteristics that reduce the incentive of shareholders to redeem [investments]," the study said. "It is critical that any new regulations …[create] a stronger, more resilient product … without imposing harmful, unintended consequences on financial markets or on the U.S. economy."

One place Schapiro could start, according to the industry insider, would be to raise awareness of the differences between MMFs and bank accounts.

"We’d rather have the message out there saying there’s risk to the investment product. The government can send a signal that they would not step in again," the insider said. "Instead of the dialogue always being increased regulations to hurt us."