Savers on losing team in fight over money-market fund rules
TERRY SAVAGE firstname.lastname@example.org February 12, 2012 5:10PM
Average American savers can’t win in a battle between banks and money-market funds. | File photo illustration
Updated: May 3, 2013 12:15PM
Did you ever wonder how the football feels? Teams of hulking men are grabbing at it, squeezing at it and falling on it — all in attempt to move it to their goal line?
Well, if you’re a saver in America, you should know how that football feels. You’ve been passed and carried around the turf without any power to change the outcome of the game. The current fight over the future of money-market mutual funds is just the latest play.
Savers have already watched their yields crunched. The Federal Reserve has promised to keep rates low until 2014 to get the economy going again. With rates on six-month CDs dropping to less than a quarter of one percent, savers who planned to live on their interest are forced to dig into their principal or take more risk to earn higher returns.
The low rates benefit the banks, giving them the ability to make a profit on the spread between the interest they charge on credit cards and mortgages and the rates they pay savers. But those accumulated profits have not been used to make new loans because the banks worry about higher reserve requirements and new banking laws.
Money fund battle
The latest battle over your savings is being waged between two true giants: It’s the banks vs. the money-market mutual funds. And the odds are you will lose no matter which of the behemoths wins.
Here are the battle lines:
Banks offer money-market deposit accounts. These accounts are FDIC insured, subject to reserve requirements and regulatory supervision.
Mutual fund companies offer money-market mutual funds. They are not — or at least were not — federally insured. But since they are required to buy only the highest quality, short-term government securities and corporate IOUs, they have always been considered a safe place to park your money.
Money-market mutual funds and money-market deposit accounts are always priced at $1. That is, if you put $100 into the account, you are assured that you can take $100 out at any time, with no penalty, price change or time restriction.
What does change is the interest rate you earn on the account. It changes daily based on short-term interest rates on the securities it purchases.
And that’s the real issue. Some money funds purchase only short-term U.S. Treasury or government guaranteed securities. Other money funds have reached for slightly higher yields by purchasing overnight corporate IOUs called commercial paper. And some money-market funds purchase short-term IOUs issued by major global banks. All of those investments are clearly detailed in the money-market fund prospectus — which few people bother to read.
At least they didn’t read the details until fall of 2008, when Lehman Brothers failed. Many money-market funds owned short-term Lehman IOUs. When the company declared bankruptcy, the funds were forced to “write down” the value of those securities. That caused each share to be worth less than the $1 value — “breaking the buck.”
Individual investors and big institutions rushed to pull their money out of money-market funds. That created the potential for even more losses since it was so difficult to sell any short-term IOUs in that frightening moment. So the Fed stepped in and guaranteed the $1 value of money fund shares, stemming the panic. That guarantee expired in September 2009. Since then, money fund investors have relied on the fund sponsors — large financial institutions — to implicitly guarantee the value of the fund investments and access to their money.
Banks and money-market mutual funds have co-existed relatively peacefully since the first funds were started in the early 1970s. At that time, the interest rates that banks could pay were set by the government. Banks paid 5 percent interest, while Savings & Loans were allowed to pay an extra one-half percent interest to help push money toward the housing industry. And another banking regulation (Reg Q) prohibited banks from paying interest on checking accounts.
By the late ’70s, when inflation was rising, the only way bank depositors could earn higher rates to keep up with inflation was by purchasing a six-month CD, which carried rates that were determined by the weekly Treasury bill auction. Those CDs required a minimum investment of $10,000.
All that banking regulation was what made money-market mutual funds so incredibly popular so very quickly. For as little as $1,000 you could earn the higher market rates and have complete liquidity to withdraw cash or write a check on your account, typically with a minimum amount of $500.
By the fall of 2008, there was nearly $3.8 trillion in money-market mutual funds, not only from small investors, but also from large money management firms seeking market rates, safety and liquidity. Thus, the rush to withdraw cash after Lehman forced the Fed to respond as if it were dealing with a “run on the bank.”
Now the banks are pushing the SEC to regulate the money-market mutual funds as if they were banks — setting aside reserves, placing limits on withdrawals and making money-market funds less liquid. Banks say that if money-market funds are too big to fail and will be rescued in an emergency, they should bear the same regulatory burdens and pay the same costs as bank deposits.
The fund industry is dead set against the new rules, which would require approval by three of the five SEC commissioners. The fund companies say the regulations would reduce confidence, not increase it. And corporate America, which counts on being able to sell commercial paper to money-market funds, is also upset, saying it would raise the cost of doing business.
The behemoths will fight it out on Wall Street and in Washington. But one thing is sure: The outcome will limit even the small pittance that individual investors can earn on their savings these days — all in the name of fairness and protection. Now you know how the “football” feels! And that’s The Savage Truth.
Post personal finance questions at TerrySavage.com and blogs.suntimes.com/savage.