Baltimore's T. Rowe Price is working through the Investment Company Institute, a trade group for mutual fund companies, which maintains that reforms adopted two years ago, after the last crisis, are sufficient. Legg Mason's CEO said last month that the Baltimore-based investment company might reconsider its commitment to the money market fund business if additional changes proved too drastic.
On the other side of the issue is Mary Schapiro, chairman of the Securities and Exchange Commission, who warns that money market funds pose a huge potential risk to investors and the financial system and says that greater safeguards are needed.
Both sides make good points. Schapiro's opponents are right to call for evidence of how existing regulations are working before news ones are adopted.
But Schapiro is correct when she says that small investors assume that money market funds are without risk — and that these are the people most likely to get burned if there's a run on the funds in a financial crisis.
For decades, money market funds have been considered as safe as bank accounts — even though they aren't backed by federal insurance like bank deposits. Money market investors count on getting their principal back with interest. Funds usually invest in highly rated corporate commercial paper and short-term U.S. Treasury and municipal securities — not the stuff to cause sleepless nights among investors. And they maintain a $1 per share price.
But several years ago, some money market funds began investing in riskier securities to boost yields and attract more investors. That came back to bite the industry during the 2008 credit crisis, when investors in the oldest fund lost some of their principal and couldn't get immediate access to their money. This caused a run on money market funds — about $300 billion was withdrawn in one week — and the federal government stepped in to insure the funds to halt the rush of redemptions.
The SEC in 2010 adopted some reforms, such as requiring funds to hold securities of higher credit quality and to maintain a greater level of liquidity to handle a sudden wave of redemptions.
Schapiro, however, says those reforms aren't enough to prevent another run on funds — or to stop small investors from bearing the brunt of losses.
The SEC hasn't released a formal proposal. The commission needs a majority of its members to do so, and right now Schapiro doesn't have the votes.
But the chairman has floated some ideas.
One is to do away with the $1 per share price that funds try to maintain. Schapiro says this price gives investors the false sense that the funds don't lose value.
In reality, she says, investment companies have stepped in more than 300 times since the 1970s to shore up funds so the share price doesn't fall below $1 — a situation called "breaking the buck."
Another option, Schapiro says, is to require funds to keep a small capital buffer as well as to institute restrictions or fees on redemptions.
The buffer, she says, would help the funds weather slight portfolio losses, which can occur daily. And restrictions on redemptions, Schapiro says, could reduce the likelihood of large institutional investors withdrawing all their money from a fund at the first hint of trouble, leaving slower-reacting small investors to absorb the losses.
Schapiro has the backing of other federal regulators but not a lot of support elsewhere. Critics say her proposed reforms could be the end of money market funds as we know them.
Investors use money market funds because they're convenient, says Mercer Bullard, an associate law professor at the University of Mississippi and a fund expert. If funds no longer have a steady $1 price, he says, then every time investors make a withdrawal, say, to pay the mortgage, they would have to recognize a capital gain or loss — a tax-accounting nightmare.
"It's important to consider the industry in light of the changes that that have been [adopted] since 2008," says Joe Lynagh, who manages Price's 10 money market funds, which have about $16 billion in assets. "It's a much more resilient industry."
If today's standards were in place four years ago, funds would have had more than enough liquidity to meet heavy redemptions in 2008, he says. And, he adds, money market funds handily weathered large redemptions during last summer's European debt crisis.
"We strongly believe the reforms in place are strong and have been stress-tested," Legg CEO Mark Fetting wrote in an email. Assets in Legg's money market funds total $123 billion.
And Maryland Treasurer Kopp argues investors are not naive.
"We do read the prospectus, and we know it's an investment," Kopp told the congressional committee. "It's not a savings account, and the reforms of 2010 and the experience of 2008 have brought that home very clearly. Treating us sort of like children is really not appropriate."