The term “moral hazard” has been thrown around a lot lately. The gist of its meaning in today’s financial markets: Once the government starts bailing out companies and investors, they start to count on it — and take bigger risks as a result.
The federal government tried to nip that expectation in the bud Monday when it let Lehman file for bankruptcy. Then it bailed out AIG. Now, the American Bankers Association maintains, the Treasury is at it again. But they’re not talking about the vague plan to do something really big that Treasury Secretary Henry Paulson mentioned this morning.
No, the ABA has its sights set on Treasury's plan to backstop money-market funds, to the tune of up to $50 billion, on a temporary basis. The idea is to reassure investors that their money-fund investments won't lose money by "breaking the buck," like the Reserve Fund did this week. (The Fed also made financing more readily available so banks could buy investments from money funds, allowing them to cash investors out more easily.)
Now, bankers have a lot of reasons to fret about Treasury's money-fund move, and in a letter to Paulson and Bernanke, the ABA is up-front about most of them. For example, federal backing for money-market mutual funds -- which aren't covered by the Federal Deposit Insurance Corp. -- makes them more attractive than banks' money-market accounts, which pay lower rates but do get FDIC backing. The ABA, not surprisingly, wants to know whether the Treasury is really going to protect unlimited money-fund investments (the FDIC covers only up to $100,000 per depositor), and why banks have been paying billions in FDIC insurance for years if this kind of relief was available at the last moment.
But what caught our eye was a different argument the ABA made: "While the action is temporary, how will you address the perception by the market that money market mutual funds now have a permanent implicit government guaranty – much like Fannie Mae and Freddie Mac did?"
Will money funds, going forward, take bigger risks, on the assumption that, hey, Uncle Sam will save the day? Stay tuned.