February 29, 2012

Sallie Krawcheck: Money-Market Funds Aren't What You Think

As recently as last summer, the largest ones averaged 45% of their investments in European bank paper

It’s been a little over three years since the Reserve Primary Money Market Fund "broke the buck," and Sallie Krawcheck took to the pages of The Wall Street Journal on Wednesday to reveal surprising–and frightening–facts about the stability of the money-market fund industry since.

Krawcheck (left), the controversial former head of wealth management at Bank of America and Citigroup began by noting that the Securities and Exchange Commission is finishing a proposal to increase regulation on money-market funds, which reportedly have combined assets of $2.7 trillion.

“The SEC's aim is to reduce the risk of a meltdown in the event of another 2008-style panic,” she writes. “Its proposal is said to include mandating capital backing for money funds and ending their convention of reporting assets at a fixed $1 net asset value–instead having it "float" to represent the funds' underlying value, as with other mutual funds.”

Krawcheck then uncovers some of the investments money funds are making, and doesn’t like what she sees.

“Notwithstanding SEC actions since 2008, [investors’] funds may not be fully safe,” she explains. “They don't know that as recently as last summer, the largest money funds averaged 45% of their investments in European bank paper, with one major player at just under 70%. They don't know that, were the investments to falter, half of the top 10 money-fund providers are not large and presumably well-capitalized banks but instead asset managers that don't have anything like banks' capital resources. “

Nor, she continues, do money-fund investors know that the largest money-fund managers have been gaining share in the industry over time, therefore concentrating and potentially heightening the risk of a failure.

“And they don't know that, while these firms will likely go to extreme lengths to avoid ‘breaking the buck,’ the $1 net asset value represents an implicit, rather than explicit, guarantee. Even then, there is no certainty that firms will be successful in raising capital in a downturn since, by definition, they will be trying to do so during a market dislocation.”

She then calls on the industry to support the SEC’s regulation, arguing that in the “in the court of public opinion–not to mention among arbitrators–implicit guarantees like not breaking the buck can become viewed as explicit regardless of what written legal disclosures may say.”

She concludes that if the industry “wants to keep the guarantee as a ‘can-do’ rather than a ‘must-do,’ then a floating net asset value would go a very long way toward signaling that the investment principle is not guaranteed.”

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