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The Problem With Money Market Funds—Revisited
They’re basically unregulated banks. We tried that once. It didn’t work.

Vernon Hill ( about me )
Posted 07/08/2009
bankstocks.com
vhill@bankstocks.com

Our recent article criticizing the S.E.C. for the toothless regulation of money market funds it’s proposed drew and outpouring of comment, mainly from readers who stuck up for the funds, and pointed out the value they’ve added to the society in general.

All of which is completely irrelevant. The main problem with money funds is this: they are unregulated banks. Which is to say, they operate without any of the safeguards banking customers take for granted. In particular, funds face no oversight and, most important of all, have no minimum capital requirements. Yet they basically do the same thing banks do: make loans, accept deposits, take maturity risks, and serve the general public.

Oh, and they siphon deposits from the real, regulated banking system.

Why would anybody think that’s a good idea? Would anyone support the idea of a large system of non-bank banks that operate under no capital constraints and without any government supervision? It was a regulatory breakdown that helped cause the financial crisis in the first place, yet a lot of people seem to think that even less regulatory oversight of de facto banks is a good idea. That’s nuts.

If the feds want to reform our financial system, proper regulation of money market funds would be a good place to start.

What do you think? Let me know!

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Comment:

Paul Volcker Posted On 7/8/2009 12:58:58 PM

I agree. Bernanke-Paulson-Geithner & Co. effectively made them government guarantied. Since they now ( essentially ) carry the full faith and credit imprimataur of Uncle Sam, they ought to bear the cost of that now-explicit guaranty.

Soldalma Posted On 7/8/2009 4:04:55 PM

MOney market funds are not banks. They cannot create money. There is no multiplier effect.

Alfred M. King Posted On 7/8/2009 4:42:21 PM

As I recall, money market funds got started when banks were precluded - by law or regulation - from paying market rates of interest on checking deposits. The funds were a way around this and ended up disintermediating funds from banks. The initial issue was an inability of the banks, for whatever reason, to be competitive. 40 years later the problems you so eloquently discuss are the consequence - whether intended or unintended.

Mark Lynch Posted On 7/8/2009 5:16:10 PM

Exactly.

Lyle S, St. Paul, MN Posted On 7/8/2009 6:54:53 PM

Right on. First of all the feds need to reform our financial system. But the system may only need teaking, but the regulatory agencies must be totally over hauled and be held accountable. But we also need legislative committees that understand the in and outs of financial institutions and sound regulatory procedures and policies. Our regulatory agencies are out to lunch in many respects. I feel many state regulatory agencies aare doing a much better job than the Feds~!

Joel Whitaker Posted On 7/8/2009 11:07:35 PM

I agree they siphon money from banks. But they aren't banks. They use that money to invest in commercial paper issued by Wells Fargo, Citi and tons of other domestic and international banks. They shouldn't be guaranteed. That's one of many mistakes the Bush-Obama Administration has made. For the most part, the reason they are successful is because major banks -- like Wells Fargo, Citi, BofA, etc. -- are paying miniscule rates on savings -- anywhere from 0.01% to 0.25%. At the same time, they are paying as much as 1.25% on commercial paper sold to money market funds. The way to solve this is simple: No government insurance for money market funds, and banks that sell commercial paper must pay their ordinary savings depositors the same they pay money market funds.

rs Posted On 7/8/2009 11:51:08 PM

wrong vernon. they should be deregulated, as should banks and ALL other sectors of the economy. this country was founded as the USA not the USSA

TeeKee Posted On 7/9/2009 12:14:04 AM

Anyone who is taking in money or deposits and investing in or making loans is an intermediary and is acting as a bank. Money Market Accounts fit that description. We need to first get rid of most of the Congress because they are too old, too slow and cannot keep up with how complex our economy has become. If we dont' we will need to constrain growth and dumb down the economy so some old guy/gal who rants about steroids one day can also sit on a financial service committee the next and ask stupid questions. Can't we have some test for congressmen or women who sit on these committees? They are killing us.

Interested Posted On 7/9/2009 1:46:04 AM

Money market funds do create money in that there is a multiplier effect. Investors in these funds in essence lend money to banks which then allow meony to be lent elsewhere at higher rates. Do agree that some level of regulation should be in effect, but my guess is that the margin on these funds is low for banks, over regulating could cause banks to reduce the offering all together.

jeldh Posted On 7/9/2009 7:13:13 AM

If money market funds shouldn't be insured, then depositors (oop- investors) should be painfully aware of that. Last time I checked, these funds were paying miniscule returns that were being subsidized by their corporate affiliates. Thanks, but not thanks. I'll put my money in a 20bp savings account at a bank, where I'll earn a higher yield and have some faith that my investment is insured.

TeeKee Posted On 7/9/2009 10:10:58 AM

Anyone who is taking in money or deposits and investing in or making loans is an intermediary and is acting as a bank. Money Market Accounts fit that description. We need to first get rid of most of the Congress because they are too old, too slow and cannot keep up with how complex our economy has become. If we dont' we will need to constrain growth and dumb down the economy so some old guy/gal who rants about steroids one day can also sit on a financial service committee the next and ask stupid questions. Can't we have some test for congressmen or women who sit on these committees? They are killing us.

Thomas Führinger Posted On 7/14/2009 9:47:12 AM

A money market fund, as the word implies, should be expected to only use investors' funds (equity) and invest in short term debt - the money market. In that case they are not acting like banks. They are not creating money and are no threat to the system - as long as there is no guarantee at the expense of the taxpayer involved. If they are taking deposits (i.e. leverage) and invest in longer term maturities, they are in effect hedge funds.

matt miller Posted On 7/14/2009 10:59:30 AM

Mr. Hill any thoughts on the impact of the California Warrants to the depository institutions who are accepting them for deposit? it seems to me that as we get into August and issuance gets close to $6 B it actually gets close to 1-2% of deposits. with no secondary market they will get a haircut in a reporting category that usually doesn't get a haircut. what do you think? MM

Greg R Posted On 8/4/2009 12:29:35 PM

The money market industry is regulated. These trusts are reviewed by SEC examineers every several years just like bankers. These funds must invest accoring to very specific rules and guidelines. Question How much have money market funds lost investors aggregate over the past twenty years? How many banks have gone into receivorship during the same period?

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