SEC’s Money Market Fund Proposal is Hypocritical

SEC's Money Market Fund Proposal is Hypocritical

 

So SEC Chairman Mary Shapiro wants money market funds to use mark-to-market accounting, and publish a daily NAV.  Well, why not impose mark-to-market accounting on banks, and force them to report the fair market value of their surplus every day? Large depositors over the guaranty limit and the repo market might be interested in this data.  Oh wait, that’s procyclical, so many claim, even though it reveals cash flow mismatches, which are material to the running of a banking business.

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There’s a lot of hypocrisy involved in the SEC’s proposals on money market funds.

  • Banks are a larger problem.  When money market funds fail, the losses are a couple percent on NAV, versus much larger on banks.
  • Having a balance sheet enables a bank to postpone the day of reckoning; there are more games to play.
  • Some banks run “money market funds” that are essentially savings accounts, but do not have identified pools of assets behind them.  In an insolvency, a holder of such is a general creditor after FDIC coverage.
  • Money market funds cost consumers a lot less than banks in order to provide transactional services.  In one sense, money market funds deserve to exist far more than banks — they have a very low asset liability mismatch, asset quality is very high, and they exist to pass through interest earnings on a short-term portfolio.

Money market funds should be treated like book value ETFs.  They should pass through interest net of fees, andimpose credit events should the NAV fall below 0.995. [Link to my letter to the SEC]  This is a simple, stable solution, that would not require any regulation beyond that.  It would keep money market fund losses small, end deliver them to holders, not taxpayers. (Even indirectly, by borrowing from the Fed.)

So there are 300+ cases where the sponsors of money market funds put up money or offered loans where money market funds were about to break the buck.  Where Mary Shapiro sees weakness, I see strength.  Isn’t it great that financial organizations, without being required to do so by regulation, kick in their own funds or liquidity in order to preserve the interests of savers? Most banks could never do the same when they are about to go bust.

Money market funds are a way of avoiding the high expenses of banks, and offer savers a decent rate of return.  If there are losses, holders of the money market fund should bear it through a reduction in units, as described in my proposal, unless sponsors generously want to preserve their franchise.

Consumers get a better deal with money market funds.  Those that are in the pocket of the banks argue against money market funds.  I do not ever want the  government to bail out money market funds, and the US Government erred greatly when they did so in 2008.  Those holding money market funds should have borne their small losses.  There would have been little risk from letting money market funds deliver losses to holders.

Those losses were not the cause of the crisis, but the banks with their bad residential mortgage loans.  That was the crisis, and continues to be so, with so many mortgages underwater.

David Merkel, CFA of Aleph Blog

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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.