Without much fanfare, there’s been a trillion-dollar upheaval in a favored corner of America’s financial system: the money-market funds where institutional and retail investors park cash to earn returns better than bank deposits offer. The turmoil has been driven by new rules that went into effect on Oct. 14. They’re meant to prevent a repeat of the crisis in September 2008, when investors found that funds they thought were as safe as banks were anything but.
1. What’s changing?
One of the most cherished practices -- or myths -- of the $2.7 trillion money-market fund industry, that a dollar invested with it is always worth a dollar. That so-called constant net asset value, or NAV, makes money-market funds seem more like bank accounts. But money-market funds aren’t banks -- they’re mutual funds, and as with any mutual fund, a dollar invested buys a share of a pool of assets whose value can fluctuate. The U.S. Securities and Exchange Commission has now gotten rid of fixed $1-a-share values for a wide swath of money-market funds. Additionally, overseers of some funds now have the ability to make it harder for clients to pull their cash in a crisis, by imposing redemption gates and liquidity fees.
2. What funds have to change?
The biggest impact is on institutional prime funds, which focus on buying short-term debt of banks and corporations, known as commercial paper. They have to allow their daily NAV to float to reflect changes in securities prices. So will institutional funds that focus on municipal debt. The idea is that the sophisticated investors who use these funds were the ones who rapidly pulled money out during the 2008 run. Funds with similar investments that cater to retail investors got to keep their fixed share value but are now able to impose gates and fees to slow redemptions in times of crisis.
3. What funds don’t have to change?
Funds that invest solely in U.S. government debt and that of its agencies, or in short-term loans known as repurchase agreements, were exempt from the changes.
4. Why are money-market funds getting these new rules?
In September 2008, as markets teetered, the $62.5 billion Reserve Primary Fund had to “break the buck” -- admit that shares were no longer worth $1 -- when its holdings of debt issued by Lehman Brothers Holdings Inc. lost their value. That triggered panic among investors in other funds, who were abruptly reminded that money-market funds, unlike banks, aren’t backstopped by deposit insurance. They withdrew about $200 billion in about two days, nearly freezing credit markets. The run abated only after the Treasury guaranteed money-fund assets against default and the Federal Reserve bought funds’ securities at face value.
5. How big a difference will a floating share price make?
The change may be more important psychologically than practically. Many fund companies and strategists predict that under normal conditions actual swings below or above a $1 NAV will be small and infrequent. The fund industry bitterly (and successfully) fought an earlier SEC proposal to do away with a fixed NAV altogether, saying that would scare away investors.
6. What’s this doing to markets?
Many fund companies, such as Fidelity Investments, converted prime offerings to government-only ones, so as to maintain the $1-a-share practice. More recently, money poured out of funds affected by the rules. Short-term borrowing got harder and more expensive for banks and corporations. The three-month London interbank offered rate, a gauge of unsecured bank funding costs, rose in October to its highest level since 2009.
The Reference Shelf
- A QuickTake explainer on how the 2008 financial crisis changed money market funds.
- An overview of the most sweeping change for U.S. money market funds in over three decades.
- A story on rising commercial-paper rates.
- What will Libor do?
— With assistance by Christopher Condon