Proposed Money Market Reforms Fail to Address Key Issues

by Jeffrey N. Gordon, for The Harvard Law School Forum at Harvard Law School, September 17, 2009.

Despite last year’s near-miss of a Money Market Fund catastrophe, the SEC’s current Money Market Reform proposal asks for only modest reforms that fail to address the key issues of this $3.8 trillion financial intermediary; indeed, that may well aggravate systemic risk.   First, the proposal does not appreciate that there are really two separate MMF types, retail MMFs and institutional MMFs, with different regulatory needs.  Retail MMF investors are looking for a bank account that combines safety with a higher rate of interest.  For them there is no substitute for fixed NAV, “safety and soundness” portfolio constraints and deposit insurance paid for with risk-adjusted premiums. Institutional MMFs, which now account for approximately 60% of MMF assets, function as low-cost providers of a corporate treasury function for large business entities.  This outsourcing saves these entities (corporations, life insurers, pension funds) the need to assemble individual portfolios of money market instruments the value of which would of course fluctuate.  Institutional MMFs thus should not carry a fixed NAV or the associated portfolio constraints.   Second, the SEC proposal fails to appreciate how MMF regulation creates systemic risk by artificially increasingly the supply of short term finance.  The consequence is to shift maturity transformation away from banks to short term credit markets, which, as last fall demonstrated, may seize-up in times of financial distress.  As suggested by the Group of 30’s report in February 2009, whether money market funds are a desirable innovation needs full scale examination…(continue reading)

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