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Rule changes

Save the money market

Mary Schapiro, chairwoman of the Securities and Exchange Commission, in an effort to make money market funds safer for investors through tighter regulation, could end up eliminating such funds as an option for investors.

That would harm 401(k) plan participants, who often use money market funds as short-term shelter from volatility, and even some pension funds, which use the funds as parking lots while making long-term decisions or while reallocating assets.

The changes also could be bad for companies that issue commercial paper to finance their day-to-day operations. Eliminating, or reducing in size, a major customer for such short-term debt — the money market fund industry — would make life more difficult for these companies and possibly harm the economy.

The changes Ms. Schapiro is seeking likely would make it more expensive for investors to buy money market funds, thereby reducing their already paltry yields and perhaps forcing many funds out of the business. If funds' usefulness as a cash management tool is significantly reduced, there is a risk that investors will turn to vehicles that are far less stable, regulated and transparent.

Rather than instituting more regulations, the SEC should continue to monitor the effectiveness of the dramatic rule changes it made in 2010. Those changes — which involved increasing the cash that such funds are required to keep on hand to meet redemptions, and boosting the credit standards for the kinds of securities in which they invest — already have proved more than adequate.

Like the rule changes made two years ago, those being encouraged by Ms. Schapiro are intended to prevent a panic like the one that occurred amid the 2008 financial meltdown. That's when the Reserve Primary Fund broke the buck due to its investments in Lehman Brothers Holdings Inc., which became worthless after that firm went bankrupt.

The run on the Reserve Primary Fund triggered massive and unprecedented redemptions at many other money market funds. In the span of two days, investors redeemed $40 billion from the Reserve Fund, or about two-thirds of the fund's total assets. In the span of one week, they yanked $310 billion from money market funds, a figure that represented 14% of the funds' total assets at the time.

The run on money funds also brought short-term-credit markets to a standstill when the funds curtailed their purchases of commercial paper. The bloodbath finally ended when the federal government intervened and guaranteed investor assets held in money funds.

The SEC should be commended for the comprehensive changes it made to money fund regulation in 2010. Without a doubt, those changes made them safer without compromising their usefulness.

The same can't be said of the proposals now on the table.

One would require the funds to build a cash cushion, ranging from 1% to 3% of assets, to help absorb losses. The main concern about this proposal is that it could have the unintended consequence of increasing, rather than decreasing, the chances of a run on a fund. Investors in a fund whose shares have dipped below $1 might rush to get their money out of the fund before the cushion is exhausted.

Requiring the funds to maintain a cash cushion also would increase costs and, with interest rates as low as they are now, drive more people to look for yield in higher-risk vehicles.

Another idea on the table is to require funds to have floating, rather than stable, net asset values.

Although a floating NAV might reduce the chances of a run by making it clear to investors that money funds don't come with a guarantee against a loss of principal — it also probably would lead to a severe contraction of the industry.

Many state and local governments, individual investors, and companies that use money funds as a cash management tool, would stop regarding the funds as stable financial vehicles in which cash earmarked for future investments or expenses can reside safely.

Again, many investors would be forced to look for other investment vehicles outside of banks.

Money market funds are one of the greatest financial product innovations of our time. Their safety and usefulness should be enhanced, not diminished, by regulation.