A Radical New Approach for Money Market Funds II


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.

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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.

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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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David J. Merkel, CFA, FSA — 2010-present, I am working on setting up my own equity asset management shop, tentatively called Aleph Investments. It is possible that I might do a joint venture with someone else if we can do more together than separately. From 2008-2010, I was the Chief Economist and Director of Research of Finacorp Securities. I did a many things for Finacorp, mainly research and analysis on a wide variety of fixed income and equity securities, and trading strategies. Until 2007, I was a senior investment analyst at Hovde Capital, responsible for analysis and valuation of investment opportunities for the FIP funds, particularly of companies in the insurance industry. I also managed the internal profit sharing and charitable endowment monies of the firm. From 2003-2007, I was a leading commentator at the investment website RealMoney.com. Back in 2003, after several years of correspondence, James Cramer invited me to write for the site, and I wrote for RealMoney on equity and bond portfolio management, macroeconomics, derivatives, quantitative strategies, insurance issues, corporate governance, etc. My specialty is looking at the interlinkages in the markets in order to understand individual markets better. I no longer contribute to RealMoney; I scaled it back because my work duties have gotten larger, and I began this blog to develop a distinct voice with a wider distribution. After three-plus year of operation, I believe I have achieved that. Prior to joining Hovde in 2003, I managed corporate bonds for Dwight Asset Management. In 1998, I joined the Mount Washington Investment Group as the Mortgage Bond and Asset Liability manager after working with Provident Mutual, AIG and Pacific Standard Life. My background as a life actuary has given me a different perspective on investing. How do you earn money without taking undue risk? How do you convey ideas about investing while showing a proper level of uncertainty on the likelihood of success? How do the various markets fit together, telling us us a broader story than any single piece? These are the themes that I will deal with in this blog. I hold bachelor’s and master’s degrees from Johns Hopkins University. In my spare time, I take care of our eight children with my wonderful wife Ruth.
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