Money Market Cash Would Be Bonanza to Collateral-Poor Banks

The WealthCycles Staff

Money Market Mutual Funds (MMMFs) have historically been a bulwark of a free-functioning economy, offering institutional investors a safe if low-yielding haven to park their cash for short interim periods and providing companies a place to stash cash needed for easy liquidity and cash flow management. Historically MMMFs earned little but historically paid a fraction of a percent more than a checking account. They evolved naturally in response to a marketplace need for ready liquidity.

Now, under the guise of protecting small investors, government regulators are on a mission to make MMMFs less attractive, by delaying quick withdrawal and potentially charging for the privilege of reclaiming one’s cash. At the root of the proposed rule change: motivating investors to move more cash into banks, stocks and bonds. So how much is in question?

Money Market History

Money market mutual funds (MMMF) were first introduced in 1971 and are most often used to reap the benefits of these three basic tenets :

· minute volatility

· maximum liquidity

· instant redeemability, or liquidity

The MMMF market has become increasingly important during the years of financial instability since 2008. These funds are frequently used to provide short-term financing for companies responding to short-term liquidity events. For this reason, timely and easy access to MMMF accounts historically has been critical to keeping the economy moving forward.

Money market funds are often thought of as cash and a safe place to park money that isn’t invested elsewhere. Investing in a money market fund is a low-risk, low-return investment in a pool of very secure, very liquid, short-term debt instruments. In fact, many brokerage accounts sweep cash into money market funds as a default holding investment until the funds can be invested elsewhere.

When first introduced, MMMFs were only offered outside the traditional banking industry and so were not subject to the Federal Reserve Board’s Regulation Q, which set the fixed rate that banks could pay on deposits. Rather, MMMF accounts are regulated by the U.S. Securities and Exchange Commission (SEC) Investment Act of 1940, specifically Rule 2a-7. The net asset value (NAV) of an MMMF represents the price of a share of the fund. Typically, MMMFs work to keep shares right at $1; this is primarily for ease of comparison and reporting. That $1 standard is the source of the phrase, “break the buck,” which Investopedia explains like this:

Central Bank Covets ‘Inert’ Funds

Like most of the world’s largest financial institutions, MMMFs suffered setbacks and losses during the economic collapse of 2008. One of the biggest hits to the MMMF market was when the massive $62 billion Reserve Primary fund, managed by Lehman Brothers, “broke the buck.” The ripples from that failure were widespread and catastrophic, contributed to the subsequent failure of Lehman Brothers and to the credit freeze that essentially stopped the economy in its tracks.

The Reserve Primary fund “broke the buck,” meaning its net asset value fell significantly below the $1 a share that it was required to maintain. That failure prompted a run on money market funds, with investors withdrawing more than $300 billion in short order.

The panic caused the market for short-term loans between companies, known as commercial paper, to shut down even for the most financially secure companies. The Treasury Department stepped in to guarantee more than $3 trillion in money-fund assets, and the Federal Reserve devised liquidity programs to shore up the financial markets.

The commercial paper market is still over $300 billion below it’s pre-bubble average, and half of the summer 2007 peak. In wake of the 2008 crisis, under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, the Financial Stability Oversight Council (FSOC) was established, ostensibly to control volatility and protect investors from too big to fail (TBTF) collapses such as that of Lehman Brothers in 2008. The FSOC is a government body consisting of 10 voting members, including the U.S. Treasury Secretary, Federal Reserve Chair and SEC Chair, and five non-voting members.

In July 2012 SEC Chair Mary L. Schapiro proposed a series of tougher rules to regulate and control the MMMF market. One proposed rule change would give MMMF fund managers the option of suspending redemption to prevent a run on the fund—a rule change that would fly directly in the face of a core tenet of mutual funds, maximum liquidity. In addition to suspending redemptions, the SEC proposed to reserve a portion of depositor funds from immediate withdrawal to absorb any potential losses, according to a New York Times report :

Another option would allow a $1 price but require funds to have a buffer of 1 percent of assets to absorb day-to-day fluctuations in the value of a fund’s investments; in addition, it would permit investors with more than $100,000 in a fund to withdraw only 97 percent of their assets immediately. The rest would be first in line to absorb the fund’s losses, thus discouraging redemptions.

The recommendations of July 2012 were abandoned after heavy lobbying by MMMF issuers. But the FSOC in November 2012 offered three new proposals :

1. Require a floating Net Asset Value (NAV);

2. Require an MMMF capital buffer of up to 1 percent of the funds value combined with requirements that only a small percentage of shareholder funds can be redeemed in a short period of time;

3. Require MMMF to maintain a capital buffer set at 3 percent to absorb losses, combined with a set of other measures that could reduce the size of the buffer if deemed “sufficiently strong” to complement the buffer.

Economy blogger Zerohedge, which has been writing about proposed MMMF rule changes since 2010, sees attempts to meddle in money markets as a first run by the Federal Reserve and its government allies at instituting capital controls, citing a July 2012 paper by the New York branch of the Federal Reserve:

Our proposal would require that a small fraction of each MMF investor’s recent balances, called the “minimum balance at risk” (MBR), be demarcated to absorb losses if the fund is liquidated. Most regular transactions in the fund would be unaffected, but redemptions of the MBR would be delayed for thirty days. A key feature of the proposal is that large redemptions would subordinate a portion of an investor’s MBR, creating a disincentive to redeem if the fund is likely to have losses.

In other words, investors who wanted to pull funds out of a MMMF would have to leave some portion of their money in the fund. Then if there was a mass run on the fund, causing its value to crash, those reserved funds left in the fund would help offset the losses. Theoretically, this would discourage MMMF investors from pulling their money out if it looked like they might lose a portion of their investments. Thus the historic money market tenet of immediate liquidity would be destroyed. More from the Fed paper:

The MBR would be a small fraction (for example, 5 percent) of each shareholder’s recent balances that could be redeemed only with a delay. The delay would ensure that redeeming investors remain partially invested in the fund long enough (we suggest 30 days) to share in any imminent portfolio losses or costs of their redemptions [i.e. socializing the losses ]…

The motivation for an MBR is to diminish the benefits of redeeming MMF shares quickly when a fund is in trouble and to reduce the potential costs that others’ redemptions impose on non-redeeming shareholders. Thus, the MBR would be an effective deterrent to runs because, in the event that an MMF breaks the buck (and only in such an event), the MBR would ensure a fairer allocation of losses among investors…

Although these proposed rule changes are cloaked in the mission of protecting smaller investors if the big dogs bail out, Zerohedge sees it (and WealthCycles agrees) as an “implicit attempt at capital controls by the government on one of the primary forms of cash aggregation available.” By disincentivizing investors from using MMMFs as a cash depository, the Fed and its planning buddies expect the capital to flow into stocks, bonds and banks instead, where those assets can be used by the custodians as collateral for more cash.

This would explain the official push to raid MMMFs. As WealthCycles has reported, the world economy is suffering a desperate shortage of “good money” collateral—assets that can be multiplied via rehypothecation, the pledging and repledging and repledging again of the same asset. Without that collateral fuel, loans against that collateral are fewer; deflation ensues.

Let us not forget that the Fed is wholly committed to increasing the supply of currency as deflation further destroys their assets, and threatens the stability of their monopoly. In addition to monetary policy, printing more dollars, there are less obvious but equally damaging ways of accomplishing this goal.

But the Fed can also effect an increase in the supply of money by increasing the stock of assets available for repledging. Giving an incentive to move money market cash into bonds or stocks could accomplish an increase in the quantity of, and possibly a lengthening of, collateral chains, as these securities can be repledged onward multiple times, creating an increase of the supply of money and credit.

Zerohedge reads more into the recent renewed push to rout MMMF cash:

The question becomes: why now ? What does the Fed know about market liquidity conditions that it does not want to share, and more importantly, is the Fed seeing a rapid deterioration in liquidity conditions in the future, that may and/or will prompt retail investors to pull their money in another Lehman-like bank run repeat.

As WealthCycles readers know, in our global economy, debt must continually expand in order to keep the monetary pyramid scheme from collapsing. The end is only a matter of time, but many powerful forces are at work to keep the scheme going for as long as possible. With true growth stalled and central banks running low in their bags of tricks, those trillions sitting in the hated MMMFs is looking mighty tempting. But as history proves, this newest ploy might buy a little more time at best, and probably not nearly as much time as the central planners believe.