Will the Government Put Money Market Funds Out of Business?

Immediately after Lehman Brothers failed, a money market mutual fund called Reserve Primary "broke the buck"--it did not have enough money in its coffers to pay the shareholders what they'd had.  Since money market funds are essentially used as bank accounts, this was a big problem--and it triggered a bank run on the money markets, which ended only when the government stepped in and said it would backstop these funds.

Despite their major role in the financial crisis, these funds haven't attracted nearly as much attention in the press, or the wonk-world, as more theatrical financial instruments like synthetic CDOs.  Not many financial journalists own synthetic CDOs.  Most of us probably have money market accounts.

At last, the government is proposing new rules, which are supposed to make MMFs less risky.  The funds would have to raise new capital, and some minor withdrawal limitations would be imposed on customers.  They would also have to offer a floating net asset value instead of the current "guarantee" that if you deposit a dollar, you'll always get at least that dollar back.

The last is all by itself disastrous for these funds, whose main attraction is that they act like bank accounts.  As for the rest, in a normal interest rate environment, this would be onerous.  But with interest rates as low as they are, there's no way for MMFs to absorb the hit by offering a lower return; it looks to me as if the interest rate would probably have to be negative.  Which is to say, your MMF would actually be charging you for the privilege of giving you their money.

If passed as proposed, the rules would seemingly put the MMFs out of business.  And perhaps that's the point--Paul Volcker, for one, has been an outspoken critic of money market funds, which originated as a way to dodge the interest rate caps on bank accounts during the inflationary 1970s.

Though the SEC has tightened up the rules on what sort of assets the funds can hold, my understanding is that there are large gaps in the way we regulate these funds--as I understand it, in 2010 congress effectively made it illegal to bail out the funds again, but was less explicit about how to keep these funds from starting another run.  These rules are an attempt to close that gap--and for sure, if we don't have any MMFs, we won't have any darn runs on them.

But it doesn't actually seem likely that these rules will go into effect as proposed.  This is the opening bid in a long negotiation.  With another crisis looming in Europe, let's hope it isn't too long.

This post has been updated to clarify the state of rule-making.
Presented by

Megan McArdle is a columnist at Bloomberg View and a former senior editor at The Atlantic. Her new book is The Up Side of Down.

The Man Who Owns 40,000 Video Games

A short documentary about an Austrian gamer with an uncommon obsession

Join the Discussion

After you comment, click Post. If you’re not already logged in you will be asked to log in or register.

blog comments powered by Disqus


The 86-Year-Old Farmer Who Won't Quit

A filmmaker returns to his hometown to profile the patriarch of a family farm


Riding Unicycles in a Cave

"If you fall down and break your leg, there's no way out."


Carrot: A Pitch-Perfect Satire of Tech

"It's not just a vegetable. It's what a vegetable should be."


An Ingenious 360-Degree Time-Lapse

Watch the world become a cartoonishly small playground


The Benefits of Living Alone on a Mountain

"You really have to love solitary time by yourself."

More in Business

Just In