Goldman Sachs Wimps Out in Buck-Breaking Brawl: David Reilly
Throughout the financial crisis, Goldman Sachs Group Inc. extolled the use of market prices to value holdings, saying this instills needed discipline. The firm’s hard-line stance turned to mush, though, when it came time to end a market myth that fueled 2008’s meltdown.
Goldman, along with the mutual-fund industry, argues that it is fine for money-market funds to use historical values, rather than market prices, to value holdings. This helps money- market funds maintain a stable price of $1 a share.
The problem: the $1 share price gives investors the false impression that money-market funds are like bank accounts and so can’t lose money. That myth was shattered in 2008, and the resulting panic worsened the credit crunch, forcing the government to backstop these funds.
In the face of opposition from the fund industry and from firms such as Goldman, the Securities and Exchange Commission so far has failed to force the $3.3 trillion money-market industry to face reality by requiring the funds to show that their shares rise and fall in value, even if by miniscule amounts. This inaction creates the possibility of future market runs and the need for more government bailouts.
At a meeting last week, the SEC endorsed beefed-up disclosures for money-market funds, along with other technical changes such as requiring funds to boost cash holdings. It stopped short, though, of even proposing that funds be required to post values that wouldn’t always neatly show up as $1 a share.
More Action Needed
SEC Chairman Mary Schapiro did say the agency would continue to evaluate money-market fund reforms, including one to require floating values.
More forceful action is needed, though, especially given that there have been calls for more than a year, most notably from a group run by former Federal Reserve Chairman Paul Volcker, to require that money-market funds either use floating values -- and so prepare investors for the idea that these instruments can lose money -- or be regulated as if they are bank products.
Recall that the failure of Lehman Brothers Holdings Inc. led to losses that caused the $62.5 billion Reserve Primary Fund, the oldest U.S. money-market fund, to “break the buck.” This meant losses fell outside a preset range, so the value of its shares suddenly fell below the fixed $1 price.
Panicky Investors
This led to panic as investors realized money-market funds weren’t as safe as bank accounts and weren’t insured by the Federal Deposit Insurance Corp. The federal government had to step in and insure money-market investments until September 2009. Fresh memories of the money-market panic even played a role in the decision to bail out American International Group Inc.
Appearing before Congress last week, Thomas Baxter, general counsel of the Federal Reserve Bank of New York, submitted testimony saying that money-market funds couldn’t have weathered an AIG failure. While those funds held $5 billion of commercial paper issued by Lehman, they held about $20 billion in notes issued by AIG, he said.
“Losses to these funds would have had potentially devastating effects on confidence and would have accelerated the run on financial institutions of all kinds,” according to Baxter’s testimony.
Requiring money-market fund values to float would help head off such problems. Investors would learn that these investments are just like other mutual funds, and so can lose money.
‘Wake-Up Call’
“Our experience with the Reserve Fund and other funds is a wake-up call that stable net asset value money funds are susceptible to runs, and we must more fundamentally rethink how they are regulated,” SEC Commissioner Kathleen Casey said at last week’s meeting.
Casey added that if the funds aren’t to face bank-like regulation, they need to move to floating values.
The industry’s case against floating values is that investors would pull cash out of money-market funds because they want investments with a stable value. That, the argument goes, would deprive American companies of a vital source of funding, since money-market funds are big buyers of short-term commercial paper issued by companies.
That is a well-worn ploy from the financial-services industry to counter any change that cuts into business. Banks used this tactic effectively in 2003 and 2004, for instance, to pressure the Financial Accounting Standards Board to water down rules that would have limited banks’ ability to use off-balance- sheet vehicles.
Goldman’s Case
The result was out-of-control securitization and under- capitalized banks, both of which played huge roles in crashing the financial system.
Goldman made the exact same “We can’t crimp companies’ funding” argument in a September comment letter to the SEC on money-market reforms. Most egregious is that Goldman’s letter argues in favor of using historical prices for money-market fund values, even though the firm has championed the use of market values for investments and financial holdings.
In an op-ed article last autumn, Goldman Chief Executive Officer Lloyd Blankfein wrote, “Markets, and ultimately investors, are better served with information that more closely reflects the judgment of the market rather than the historical price.”
Now Blankfein’s boys are trying to play Jack Nicholson in “A Few Good Men,” screaming at the SEC and investors: “You can’t handle the truth!”
Guess what? It’s Goldman and money-market funds who can’t handle the truth. Investors can, if it means they don’t have to face more market crashes and government bailouts.
(David Reilly is a Bloomberg News columnist. The opinions expressed are his own.)
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To contact the writer of this column: David Reilly at dreilly14@bloomberg.net
To contact the editor responsible for this column: James Greiff at jgreiff@bloomberg.net
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