Having Wrecked the Banks, the Feds Target Money Funds
Though the interim years make the late ‘90s increasingly hazy, back then cash management via money market funds was a fairly simple concept. Investors to varying degrees wanted easy access to cash, and they enjoyed yields on cash holdings that seemed to fall in the 4%-5% range.
Of course in the late ‘90s 5% returns were seen as all-too-boring given a stock market that kept testing new highs. Still, investors who wanted to be cautious with at least a portion of their wealth could count on reasonable compensation for the short-term use of their cash.
Notable for central bankers and economic commentators today who believe that an increased Fed funds rate would "hammer" the economy, back then the U.S. economy soared and the stock market roared alongside a Fed funds rate quite a bit higher than the zero rate that prevails at the moment. But rather than allow the market economy to work free of intervention, once stocks began to crater in 2001 the Fed got to work on "fixing" things.
Though downturns or market corrections and the tight credit they foster in the near-term are healthy inputs for a quick recovery, Fed officials, having learned all the wrong lessons from the ‘30s, increasingly operate as though any failing business concept must be inundated with credit so that bad ideas can be kept afloat. So in the early part of the new millennium the Fed slashed rates repeatedly to ease the alleged burden of a correction within the Internet space.
Here it should be said that falling rates on Treasuries necessitated some amount of Fed ease, but as is often the case, the Fed overdid it. The Fed's actions then can't be separated from the eventual problems that revealed themselves within money market funds in 2008.
Though cash management had once been more of an afterthought, low rates meant that conservative investors couldn't achieve the returns they once did on short-term savings. Presumably eager to please customers used to better returns, money market funds grew a bit more aggressive on the way to short-term holdings that were exposed as very much not like cash in 2008.
As is well known now, the Reserve Fund in particular ran into trouble due to holdings of the Lehman variety, and if the Feds hadn't stepped in, the "buck" would have been broken. Though money market funds had long been seen as among the safest of all investment vehicles, investors in them suddenly faced the prospect not of minuscule returns, but negative returns that would reduce the amount of dollars in their accounts.
About this, it bears asking why this was a calamity such that the federal government needed to step in. Particularly now in what remains a low interest rate environment, the buck is theoretically broken with great regularity. Indeed, at the moment those in cash get microscopic returns from their money funds, and considering how often we're all forced to use ATMs that cost anywhere from $2.50 to $4.00 per transaction, it seems we voluntarily break the buck on a daily basis.
After that, assuming a run on the Reserve Fund, the latter's holdings surely had some value such that investors wouldn't have been wiped out altogether. And then assuming they weren't made whole, this would have been a healthy market event reminding the conservative to be even more prudent through spreading their cash around prosaic money market funds much in the way they do so with shares of companies. A quality economic lesson would have been learned.
Back to reality, troubled money market firms were bailed out in 2008 amid a political/economic crackup that said failure, despite it having authored nearly every economic advance known to mankind, would not be allowed. Money market funds survived thanks to government largesse with the money of others, though as is always the case when governments bail any sector out, eventually they return for their payment. Sadly, payment always comes in the form of regulations that ensure less of a focus on profit.
All of which brings us to the SEC's proposed regulatory plan that would require companies in the money market space to set aside holdings so that they're ready and able to handle redemptions should another financial crisis occur. Translated, having bailed the money market sector out in 2008, the federal government now seeks to weaken it on the way to market irrelevance.
As it is, money market firms continue to suffer wildly distorted rates of interest on short-term credit that make the provision of any kind of yield for customers difficult to achieve. Basically the government that wrecked money market returns through its naïve policies of near zero rates now wants to make it even more difficult for them to achieve any kind of yield on the funds invested with them.
This won't happen, but better it would be if the Federal Reserve floated the short rate it now sets so that market realities would dictate the cost of short-term credit. If so, conservative investors, having grown used to negligible returns in money market funds, would suddenly find themselves once again being compensated for their highly liquid holdings. As for money market firms, they'd have less of an incentive to aggressively search for questionable yield given these new rate realities.
Barring that, and assuming passage of the SEC's proposal, the money market space will be hit in two cruel ways such that the sector's eventual strangulation becomes more likely. Low rates created by government distortion will make finding credible yield a tough concept, and then rules dictating reserves will make achieving even microscopic returns even more of a challenge.
Here's hoping cooler heads prevail such that the SEC's bad idea dies a quick death. Markets can fix this problem; that is, if we allow them to.