Henry Kissinger used to remind us that even paranoids have real enemies. Considering the variety of proposals floated recently to restrict money market mutual funds, one need not be paranoid to think that people at some government agencies really want to put MMFs out of business.
One of the early proposals was to force MMFs to use a floating net asset value, rather than the fixed NAV that has been the hallmark of MMFs for decades. Not only would a floating NAV deprive a variety of MMF users of the predictability and utility of the dollar-in-dollar out feature, but it would also be likely to accelerate runs, rather than deter them as the proposers posit, as shareholders ran for the exits at the first inkling that the NAV might fall.
Then were those who thought MMFs should be required to have a layer of capital — a curious notion in light of the fact that MMFs today have nothing but capital. Little thought seems to have been given to such questions as what the cost of such capital would be or who would bear the burden of such cost. Nor do they seem to have considered that some $12.2 billion in new capital would be required if the capital charge were as little as 50 basis points on assets, as some have proposed &mdash a staggering number in today's market, and a number that would inevitably force a significant diminution in the aggregate size of MMFs. Furthermore, almost certainly the cost of such capital would ultimately be borne by fund shareholders, making MMFs significantly less attractive.
Then consider some of the more recent ideas. One is to impose a nonrefundable fee if shareholders want to redeem their shares when certain market conditions exist. Another is to impose a three percent, 30-day "holdback" on MMF redemptions whenever they occur. That is, whenever a fund shareholder wanted to redeem shares, three percent of the redemption amount would be withheld for a month. Earlier versions of this holdback concept would have made it contingent on the occurrence of specified market events that might affect liquidity, but staffers now seem to believe that an unconditional holdback would alter shareholders' expectations, eliminate the advantage of being first to exit, and thus dampen the prospect of "runs."
A charitable view of these recent proposals is that, like the earlier proposals, they are unburdened by any understanding, let alone careful study, of how MMFs are used, or what the effect of redemption fees or holdbacks would be on investors' willingness to use MMFs, or on the issuers of commercial paper, who look to MMFs as a primary source of their own liquidity.
A less charitable view is that these proposals are really intended to abolish MMFs, by saddling them with enormous new capital requirements and making them extremely unattractive for the 30 million investors who now use them.
This latter view has some historical support, for it was none other than former Federal Reserve Chairman Paul Volcker, who for years has made no secret of his strongly held view that MMFs should be absorbed back into the banking system, and who as early as 1981 suggested that MMF shareholders should either be required to give prior notification of redemptions or be subject to a holdback.
Money funds are used in literally millions of brokerage, trust and other accounts as a convenient and efficient cash management device. They are used by innumerable corporate and local government treasurers to house temporarily idle funds. And they are used by a myriad of individual investors who want a safe and reliable place to store their liquidity until they are ready to use it, with the convenience of access by check. The expectation of dollar-in-dollar-out treatment is of critical importance to these investors' choice of an MMF as repository for their liquidity.
Could a broker or trust officer in good conscience – let alone consistent with fiduciary obligations — put the idle cash balances of customers into an account that would impose a nonrefundable fee or a three percent haircut when it came time to reinvest those funds in a longer term investment? Would a corporate treasurer looking for a place to hold funds for future payrolls accept the idea that they would have to gross up any MMF investment to account for the haircut? Would an individual facing a tax payment in April put his or her year-end bonus in an MMF knowing that at tax time they might be subject to a nonrefundable fee or that only 97 percent would be available to pay taxes? Would a housewife interested in using a fund to pay bills put money in an MMF if there were a danger of incurring a nonrefundable fee or a three percent holdback every time she wrote a check? It does not take elegant economic analysis to answer these questions in the negative.
Of course, those who have surfaced these ideas have provided no empirical evidence to assure that holders of cash would simply acquiesce in the nonrefundable fee or the three percent holdback, but common sense tells us that any such tax — and that is what these ideas really amount to — would make MMFs significantly less attractive to money managers, institutions and households. Facing the loss of a portion of their investment, or the inability to redeem all of it when they needed it, they might as well use bank accounts, where withdrawals can be made at par.
Aha! Could this be what the Volcker votaries really intend? Pardon my paranoia.
John D. Hawke, Jr., a partner in Arnold & Porter LLP, Washington, DC, formerly served as Under Secretary of the Treasury for Domestic Finance, Comptroller of the Currency and General Counsel to the Board of Governors of the Federal Reserve System. He represents Federated Investors, Inc., a sponsor of money market mutual funds.
