Let Mutual fund companies that do this set up a special “crisis lending fund”

Last week, there was an article in Barron’s describing how many mutual fund families take advantage of a provision in the law allowing them to have funds lend to one another.  Quoting from the article:

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Under normal circumstances the Securities and Exchange Commission bars funds from making “affiliated transactions,” but there’s a loophole in the Investment Company Act of 1940 for funds to apply for an exemption to make such “interfund loans.” Until recently, few fund families applied for this exemption. None had before 1990. From 2006 to 2016, the SEC approved just 18 interfund lending applications. But since January 2016, the agency has approved 26. Most major fund families—BlackRock, Vanguard, Fidelity, Allianz—now can make such loans. Stiffer regulations of banks, which are now less willing to offer funds credit lines, partly explain the application surge.

I’m here tonight to suggest making a virtue out of necessity, because one day this practice will be banned after another crisis if something goes afoul.  Let the mutual fund companies that do this set up a special “crisis lending fund,” and put in place the following provisions:

• The various funds that can borrow from the crisis lending fund must pay a commitment fee for the capital that could be lent.  Make it similar to what a bank provides on a revolving credit line.
• When funds are not lent, it is invested in Treasury securities, or something of very high quality, in a five-year ladder.
• When funds are lent, they receive a rate similar to rates current on single-B junk bonds.
• The lending to other funds is secured, such that if the loans are collateralized by less than 200%, the loans must be paid down.  I.e., if the fund has $200 million of net asset value, there can be at most $100 million of loans, from all parties lending to the fund.

This would be an attractive, somewhat countercyclical asset for people to invest in.  Who wouldn’t want a fund that made additional money during a crisis, and was safe the rest of the time as well?

Just a stray thought.  As with many of my ideas, this would help create a stable private-sector solution where the government might otherwise intrude.