August 2nd, 2014
in Op Ed
by Lance Roberts, StreetTalk Live
SEC Rules To Put "Gates" On Money Market Funds
This past week the S.E.C. passed a new rule when they voted 3-2 to require institutional money market mutual funds to adopt a floating net asset value. The SEC also imposed liquidity fees and redemption gates, changes that muni market groups have said will hurt the market as well as state and local governments.
The redemption gates are discretionary, and there are potential liquidity fees of up to 2% if an MMF's level of weekly liquid assets falls below 30% of its total assets. It is up to each fund's controlling board to impose a fee or restrict redemptions in times of stress, giving the board time to figure out a way to meet those redemptions.
I penned some brief thoughts on the issue in Thursday's post "3 Things To Think About." However, I followed up with several more in Friday's "5 Things To Ponder" with several articles worth reading on this issue to gain a more balanced viewpoint on the potential consequences and risks of the recent ruling.
However, here are the main risks as noted by SEC Commissioner Kara Stein who was one of the two dissenting votes:
"Redemption gates are the 'wrong tool to address risk,' said SEC Commissioner Kara Stein during open meeting.
Fear incentives will result in 'greater chance of fire sales' in times of stress and spread panic to other parts of the financial system while denying investors and issuers access to capital.
- 'Money market funds are only one part of wholesale funding markets that need to be strengthened.'
- In the event, the gate imposed increases; investors have a 'strong incentive to redeem ahead of others.'
- While a gate may be good for one fund, 'it can be very damaging to the financial system as a whole.'
- When the gate for a fund is used, it does not mean the 'impact on wholesale funding markets will be prevented.'"
She is spot on.
The problem is that the "rule" misplaces the real "risk" in the market which is the "emotional" bias of investors. The Federal Reserve itself, in April of 2014, that:
"The possibility of suspending convertibility, including the imposition of gates or fees for redemptions, can create runs that would not otherwise occur... Rules that provide intermediaries, such as MMFs, the ability to restrict redemptions when liquidity falls short may threaten financial stability by setting up the possibility of preemptive runs."
The Fed is correct. When the FIRST money market fund throws up a gate, because the decision is left to the individual fund's board, the rest of the market will panic and pull funding in "anticipation" that it will happen to them.
Even though "retail money market" funds are not included in this decision, when the headlines of money market funds "gating" withdrawals appears the panic will then ignite across all spectrums of funds. Furthermore, you may be invested in an affected fund and just not realize it as noted in the Financial Times:
"Funds targeted at retail investors will be exempt from the floating share price, but the rule catches all institutional funds except those investing only in federal government securities. The industry has long expected that the $900bn in so-called prime funds, which invest in short-term corporate debt, would be affected, but the reform also catches $70bn in municipal debt funds,potentially raising borrowing costs for US cities and states.
'The [rule] impedes one of the commission's stated goals of this reform effort - 'preserving, as much as possible, the benefits of money market funds,' said commissioner Michael Piwowar, who objected to the floating rate. 'Therefore, the continued utility of institutional prime and tax-exempt money market funds as a cash management tool is highly questionable.'"
Pater Tenebrarum, however, had one of the salient impacts of the ruling which is the "weakening of property rights of individuals:"
"The floating requirement obviously favors the banking industry over money market funds, as these funds have been used by investors as a cash equivalent, bringing a slightly higher return than could be had from a bank deposit. Once their unit prices begin to float, they will no longer be seen as cash equivalents, so banks will enjoy an advantage."
(hmm...I wonder who might have been lobbying the SEC for the rule change?)
"This advantage is unfair, because bank deposits are by no means safer. On the contrary, since they are fractionally reserved, and the assets 'backing' them often have far longer maturities than the short term debt money market funds as a rule invest in, they must be regarded as inherently riskier.
The adoption of 'redemption gates' effectively means that money market fund boards will be able to suspend the property rights of their customers. Once again, this creates a significant disadvantage for the money market fund industry in favor of banks, since demand deposits will continue to lack such 'redemption gates,' in spite of the fact that banks are de facto unable actually to pay out all demand deposits, or even a large portion of them, 'on demand'."
This action by the SEC leads to several important questions:
- Are retail customers exempt because the SEC believes they are simply too stupid to react to crisis conditions?
- Why are such regulations held to be required at all?
- What does the SEC know that you do not?
- Is a crisis brewing we are not aware of?
- Are regulators implying that the system has not been 'made safe' after all?
- This move is a great benefit to the recapitalization of banks that need capital deposits. Is the banking system in trouble again?
First of all, there is no reason to panic and do anything just yet. However, the very presence of the rule substantially increases the risk to individuals and the markets.
Secondly, the obvious solution is to move money to FDIC insured bank accounts and out of "money market" mutual funds which are regulated by the SEC. However, this is not an optimal solution of managing an investment portfolio.
Important note: I am going to research options with our two primary custodians (Fidelity and Schwab) and will share what information I discover. In the meantime, you may want to contact your brokerage firm and ask them what options they have available.
You will be told that there is "nothing to worry about" and that the rule does not apply to you. As discussed above, it will have a significant impact on you when a crisis occurs. Brokerage firms have an enormous incentive to keep you invested in mutual funds as that is how "fees" are created. If you move funds to an FDIC insured bank account it reduces the "fees" they can charge you.
While there is NOT CURRENTLY A RUSH to do anything, understanding your options and being prepared can pay huge dividends when the time comes.
Alan Greenspan Still Doesn't Get It
Former Fed Chairman Alan Greenspan recently did an interview with WSJ MarketWatch discussing his views on the real effectiveness of the Federal Reserve.
While he claims to be a student of the markets and human nature, he still clings to the idea that "bubbles are caused by human nature."
David Stockman recently penned an excellent missive on Greenspan's shortcomings stating:
"Alan Greenspan just cannot give up the ghost. During his baleful 18-year reign, the Fed was turned into a serial bubble machine-and thereby became a clear and present danger to honest free market capitalism and an enemy of the 99% who do not benefit from the Wall Street casino and the vast inflation of financial assets which it has enabled. His legacy is a toxically financialised economy that has extracted huge windfall rents from Main Street, and left it burdened with overwhelming debts and sharply reduced capacity for gains in real living standards and breadwinner jobs.
After all this time Greenspan still insists on blaming the people for the economic and financial havoc that he engendered from his perch in the Eccles Building. Indeed, posturing himself as some kind of latter-day monetary Calvinist, he made it crystal clear in yesterday's interview that the blame cannot be placed at his feet where it belongs:
I have come to the conclusion that bubbles as I noted are a function of human nature.
C'mon. The historical record makes clear that Greenspan panicked time and again when speculation reached a fevered peak in financial markets. Instead of allowing the free market to cleanse itself and liquidate reckless gamblers employing too much debt and too many risky trades, he flooded Wall Street with liquidity and jawboned the speculators into propping up the casino."
However, there is no better indictment of the Fed's continued shortcomings than the following quote from his interview.
"When bubbles emerge, they take on a life of their own. It is very difficult to stop them, short of a debilitating crunch in the marketplace. The Volcker Fed confronted and defused the tremendous inflation surge of 1979 but had to confront a sharp economic contraction. Short of that, bubbles have to run their course. Bubbles are functions of unchangeable human nature..."
The reality is as shown in the chart below that every "boom" and "bust" in the markets has in some way been directly attributed to the actions of the Federal Reserve "tampering" with market forces.
Janet Yellen and her cronies are embarking on the same misguided path as all of their predecessors assuming that they can control something that is uncontrollable. The result will most likely be no different.
I agree with Alan's statement:
"I do believe that central banks that believe they can quell bubbles are living in a state of unrealism."
Have a great weekend