Money-Market Resistance

CAMBRIDGE – The United States Securities and Exchange Commission (SEC) recently rejected proposed rules aimed at making money-market funds safer in a financial crisis – a rejection that has caused consternation among observers and other regulators. Given the risks that money market funds can pose to the global financial system, as shown by their destabilizing role in the 2008 financial crisis, it is not hard to see why they are worried.

Money-market funds take excess cash from investors and use it to purchase short-term IOUs from businesses, banks, and other financial institutions. They mimic bank accounts by allowing investors to write checks and promise that their investment’s value will not fall.

In 2012, American “prime” money-market funds, which buy bank and corporate debt, were worth nearly $1.5 trillion. The money flowing through these funds went to many of the world’s largest banks, including not just the obvious US suspects (JP Morgan Chase, Bank of America, and Citi), but also major European and Japanese banks such as Barclays, Deutsche Bank, Bank of Tokyo, Sumitomo, Credit Suisse, and ING. These six international banks alone accounted for nearly 20% of the prime money-market funds’ value.

Many readers know how money-market funds work: An investor buys a $1.00 share from the XYZ fund, which keeps each share’s value at a constant $1.00, allowing the investor to believe that the money – invested in a pool of safe, secure, but not always government-guaranteed assets – is on deposit. Even if the asset pool declines in value, the fund’s managers keep the value of each share at $1.00 by rounding upward the fund’s real value. If the fund’s losses are big enough that rounding off still leaves it short of a stable $1.00 value, the fund “breaks the buck.”