Weighing the Consequences of a Money Fund Overhaul

Weighing the Consequences of a Money Fund Overhaul

Anyone know what to do with $ 2.6 trillion?

That’s the sum managed by money market funds, a type of mutual fund in which companies and individuals park their cash. Regulators are pressing hard to overhaul money market funds, advocating measures they say would make the funds more resilient to financial panics. The industry opposes the measures, arguing that they are unnecessary and could cause the funds to shrink drastically.

If the money fund sector were to contract markedly, investors would have to find alternative places to park their cash. Such a shift could have important consequences for the financial system.

Before looking at what those might be, it’s worth considering that money market funds may in fact survive the changes largely intact. The fund companies may be overstating the economic impact of proposed overhaul measures, like requiring the funds to hold loss buffers.

Also, investors may not all head for the exit if their shares in the funds go from being fixed at $ 1 to floating in value, which is another of the proposed changes. And the funds may soon get a big inflow of new money if, as looks likely, a type of federal guarantee on bank deposits ends.

Still, if a large amount of money flowed out of the funds, it would mostly end up in the banks, according to analysts.

“Bank deposits would clearly get the lion’s share,” said Pete Crane, president of Crane Data, which publishes Money Fund Intelligence, an industry publication.

Assets managed by American money market funds peaked at $ 3.9 trillion in January 2009, according to Mr. Crane. A substantial proportion of the $ 1.3 trillion decline since then has probably ended up in banks, he says.

In some ways, the regulators might favor a greater shift of money to the banks they oversee. It would further the broad policy aim of paring back the shadow banking system, the name given to an array of less regulated financial activities and entities.

The additional cash might make it easier for banks to meet new regulations.

For example, banks are being required to have set amounts of liquid assets on hand. The Clearing House, a banking industry group, recently asked for a loosening of these regulations. If the banks get a big cash windfall from the wind down of money market funds, the new liquidity rules would be easier to meet.

Also, banks may allocate the money in a more rational way than money market funds do.

The funds’ corporate investments are very much skewed toward paper issued by foreign banks. One reason is that foreign banks often have the sort of high credit ratings that the money funds require. In reality, though, the foreign banks may be shakier than American corporations with lower ratings. With the freedom to care less about ratings, an American bank could invest less in foreign banks.

But there are concerns about what might happen if large American banks end up with a piles of money market cash. Such moves might help some of them grow even bigger, exacerbating the “too big to fail” problem.

Also, the money market fund industry argues that the funds are far more transparent than bank balance sheets. Investors in money market funds know exactly what assets their money is being invested in. They don’t get that with bank deposits, the fund industry says.

Not all of the money leaving money funds would go into banks. A significant proportion could go into vehicles that aren’t subject to strong regulation, like offshore money funds, private funds and other types of investment pools. This would run contrary to regulators’ wishes.

As regulators push forward with a money fund overhaul in 2013, they will no doubt be giving much thought to the consequences. After all, $ 2.6 trillion is a lot of money.


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