RIP Money Market Reform

SEC chairman cancels vote on proposals for reforming the money market industry.

WASHINGTON, DC - JULY 18: Chairman of the Securities and Exchange Commission Mary Schapiro speaks during a meeting of the Financial Stability Oversight Council (FSOC) July 18, 2012 at the Treasury Department in Washington, DC. Members of FSOC voted during the meeting on a report to Congress regarding a study of contingent capital required by the Dodd-Frank Act, and also voted on the Council's annual report.

Conceding that she could not marshal enough support, SEC Chairman Mary Schapiro has canceled an upcoming vote on contentious proposals for reforming the money market industry. Schapiro's move came after Commissioner Luis Aguilar, whose support Schapiro needed to push the proposals over the goal line, indicated that he was not yet ready to give them the green light.

Under the proposals, which are explained in more detail here, money market funds would have been required to either "float" their net asset values or, in the alternative, keep specified capital buffers. For Schapiro, a tenacious advocate for reform, scrapping the vote constitutes a large setback. For the fund industry, which was recalcitrant in its opposition, the current proposals' (at least temporary) demise is a notch in the victory column.

Money market reform has been at the forefront of the SEC's attempt to impose additional safeguards to prevent a recurrence of what happened to the financial sector in 2008. In September of that year, the Reserve Primary Fund's value dipped below $1 per share. In industry parlance, that means the fund "broke the buck." This event, which was precipitated by the fund's exposure to Lehman Brothers, set off a mass exodus from the fund and contributed to the economic meltdown.

Throughout much of the debate over money market reform, it seemed as though the Reserve Primary Fund truly was an exception to the rule in the money market industry. If what happened to the fund was a freak accident, so the argument went, then there was no need to fix the system.

At first blush, this argument seems plausible. Indeed, the fund industry's persistent claims that money market funds are safe enough without further reforms ultimately carried the day.

But a recent study casts doubt on whether the money market industry is actually as sound as its backers claim. The study, conducted by the Federal Reserve Bank of Boston, shows that during the downturn, several fund providers had to subsidize their own funds to keep them stable.

The Boston Fed points out that although the Reserve Primary Fund captured the bulk of the national attention, other funds came very close to the brink. "It is commonly noted that in the history of the Money Market Mutual Fund (MMMF) industry only two MMMFs have 'broken the buck,' or had the net asset value per share (NAV) at which they transact fall below $1," the bank notes in the study. "While this statement is true, it is useful to consider the role that non-contractual support has played in the maintenance of this strong track record."

In particular, the Boston Fed concluded that between 2007 and 2011, 78 funds received a combined total of at least $4.4 billion in aid from the companies that run them. The bank concluded that without such measures, 21 of the funds would have broken the buck.

The picture painted by this study is far from rosy. Of course, it is not at all clear that Schapiro's proposals would have actually succeeded in keeping money market funds stable during economic crises. But what is clear is that there were a number of close calls for money market investors. The Reserve Primary Fund, it turns out, was just the tip of the iceberg.

In one sense, though, the proposals' demise is good news for the stability of money market funds. At least in the short term, any changes would likely have caused a great deal of anxiety and outflows. In the longer term, however, it remains to be seen whether a lack of further regulation will prove to be detrimental.

For her part, Schapiro has vowed to keep fighting. "The issue is too important to investors, to our economy and to taxpayers to put our head in the sand and wish it away," she said, according to the New York Times.