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Money Market Reforms: Change for Your Buck?

Richard Satran

Ever since a big money market fund "broke the buck" during the financial crisis in 2008, financial reformers have been calling for an end to such funds' claims that $1 invested is always worth the same amount.

But after five years of study and debate, and numerous proposals to force the end of the "buck" guarantee, the Securities and Exchange Commission is now backing a plan to let leading fund companies keep the guarantee in place for retail fund holders. Some regulators were pushing for a requirement that funds abandon their guarantee that a dollar kept in a money market fund would always return a dollar when savers cashed out, and instead do what other mutual funds do: redeem funds at whatever the net asset value is for the fund holdings that day.

Still, the proposals, if approved, could mean big changes for widely held money market funds, and the timing could be difficult. The changes would likely be put into effect next year just as the Federal Reserve is expected to start boosting interest rates, and even short-term bonds (the sort favored by such funds) could lose value. For many investors, money market funds are considered safe havens in such periods.

So what would the proposed changes mean for average investors?

The "buck" guarantee will remain in place if you are in a retail fund. (The SEC defines this as funds that limit daily withdrawals to $1 million.) Unless your fund is hit with unusually heavy withdrawals, every dollar you invest will be redeemed when you want to get out.

For retail funds that do get into trouble - and that's only happened a couple of times in the history of the funds - there are new provisions aimed at slowing down a potential run on the fund. In certain situations, the fund, for both retail and institutional holders, will be required to charge money market holders a fee of 2 percent if they want to get out.

[Read: Why Mutual Fund Investors Are Steering Clear of Stocks.]

For larger institutional funds, the SEC proposes ending the "buck" guarantee and requiring them to move to floating rates over the next two years. That would mark a major change for the fund industry. The impact would be widespread, and promises to reshape the $2.5 trillion market in ways that may be difficult to forecast.

For starters, institutions that invest in the funds - pension funds, company treasuries and other large cash holders - would have to work harder at assessing risks for funds that will rise and fall with interest-rate fluctuations. The dollar they invest could be worth a few cents less when they withdraw money. It sounds inconsequential, but given the billions stashed in those accounts, those pennies can have a major impact. For starters, tax questions will become far more complex. Investors will have less certainty about funds at their disposal and higher costs for doing business as accounting and trading the funds becomes more time-consuming and volatile in a floating-rate world.

Retail investors will largely be spared the mess since they would still be "buck" holders. But even small investors would feel the impact if more fund companies get squeezed out in a low interest-rate environment, critics of such changes say. The largest money market funds will probably get larger. That could mean fewer options for investors. This has been a key issue raised by Investment Company Institute, the powerful trade group that represents the funds in Washington. It warned in a statement after the new rules were proposed that "changes must preserve choice for investors by ensuring a continued robust and competitive global money market fund industry." It supported the provisions aimed at heavy withdrawals but took no position on the floating-rate issue, which has divided its membership.

[Read: Are There Too Many Mutual Funds?.]

New rules could also cause a further decline in the share of Americans' savings put into money market funds. The $2.5 trillion parked in these funds has stayed at close to the same level for the past decade, while bank deposits have grown. Bank deposits now total $14 trillion, according to Federal Deposit Insurance Corp. data. A decade ago, the total was $8 trillion. Money market funds held about one-quarter of the amount banks held 10 years ago. That's slipped to 17 percent now.

Discussions over how to regulate money market funds have dragged on for years following the 2008 crisis. Back then, money markets were at the center of the storm after Lehman Brothers, a large money market player, triggered an unprecedented event. Its failure left an unknown amount of bad debt in the banking system and no one knew who was safe to deal with. The credit process used to fund companies throughout the country froze as a result, and the market balked at buying all kinds of formerly easy-to-sell securities. Ultimately, the U.S. government stepped in to guarantee money market funds' safety.

The latest rules are designed to protect taxpayers and investors from a systemic failure while maintaining such funds as a vital source of short-term funding for a sizeable swath of the economy. Money market funds remain big buyers of the sort of corporate debt that's key to the day-to-day operation of the financial system.

"These measures, if adopted, would reduce the likelihood of a run on money market funds," says Jay Baris, a lawyer who runs the investment management practice Morrison Foerster and is vice chairman of the Committee on Federal Regulation of Securities of the American Bar Association's Business Law Section.

[Read: 7 Mutual Funds That Make Huge Bets.]

He says the proposals, which will require another SEC vote after the 60-day review period, will also face scrutiny from a wide range of private- and public-sector participants who will have differing views. Most notably, the FDIC has been critical of the proposals for not going far enough to guard against a run on the funds.

Mary Schapiro, former SEC chief and the most vocal advocate for reform, proposes that all money market funds, even retail ones, be priced based on net asset value, the same way other funds are, and not priced based on the fictional "buck" level. Schapiro warned that the dollar guarantee gives investors "a false sense of security" about the health of their fund holdings. She has also pushed a plan to limit withdrawals to 97 percent of an investor's assets if their fund is targeted by heavy withdrawals. The remaining 3 percent would be used to help the fund recover and could be returned to the investor after 30 days.

"It's a delicate balancing act," Baris says."There are a lot of moving parts, and they are trying to do a lot of things at once."

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