As money-market funds swell, critics say fat yields are taxpayer subsidized

Money-market funds use investor money to buy shorter-term debt obligations like government bonds, and the mismatch between investors’ ability to redeem their money daily and the funds investment in debt with longer maturities creates the risk of a dynamic similar to a bank run.

The investment vehicles have surged in popularity as rising interest rates have enabled fund sponsors to pay higher dividends. Money-market funds now manage close to $8 trillion in assets, according to fund flow data from EPFR, and have seen greater inflows than any other major fund group since the beginning of 2022.

“In 2008 and 2020, sparks emanated from registered funds, particularly money market funds…putting everyday Americans at risk,” SEC Chair Gary Gensler said in a May speech, noting that during both episodes, the Federal Reserve created special facilities to backstop money-market funds and prevent a run on their assets.

The SEC has proposed new rules that would require money-market funds to keep a larger share of their portfolios in highly liquid assets whose price typically doesn’t fluctuate greatly.

It is also considering instituting a “swing pricing” rule that requires some sponsors to adjust the amount of money an investor can redeem from a fund based on the impact that redemption would have on the fund’s liquidity.

Critics of the fund industry argue that money-market funds are similar to high-yield bank accounts, which aren’t subject to the same regulations, like capital requirements, that banks must conform to to ensure financial stability.

“If you’re going to masquerade as a bank product, you should be treated as a bank product,” Stephen Hall, legal director with the financial-reform group Better Markets, said in an interview with MarketWatch.

Hall supports the SEC proposal, but argues that it doesn’t go far enough in part because the SEC has so far decided to focus its reform efforts on money-market funds used by institutions rather than retail investors.

Retail money-market funds aren’t required to show investors that the value of their investment fluctuates over time based on the performance of the investments made by the fund, which he says creates the illusion that these products are as safe as a bank deposit. The SEC’s swing pricing proposal would also be focused only on institutional funds, which the regulator says are more likely to experience a run.

Meanwhile, the industry is fighting the swing pricing proposal as an unworkable idea that will render money-market funds much less useful to institutions.

“Investors are going to lose a very valuable tool if the SEC pushes this ahead,” Stephen Bradford, senior director for public affairs at the Investment Company Institute, told MarketWatch. “We wouldn’t be surprised if companies just stop sponsoring these products.”

Industry representatives also argue that regulators description of their actions in 2020 as a bailout of the industry is unfair, given that the Fed set up lending facilities for a range of institutions, ranging from states and localities to small businesses.

The SEC’s reform effort is occurring alongside a broader conversation over how to prevent bank runs like those experienced by Silicon Valley Bank and First Republic Bank earlier this year. Michael Barr, the Federal Reserve’s vice chair for supervision on Monday proposed increasing capital requirements for banks with more than $100 billion in assets, so they are more resilient during times of economic stress.

Read more: Fed’s Michael Barr proposes new capital requirements for banks with $100 billion or more in assets

Some reformers want to see capital requirements imposed on money-market funds too, while others would go further by giving these funds access to the Federal Reserve’s discount window in times of financial stress.

Better Markets’ Hall argues that robust capital and liquidity requirements could go a long way toward ending bank runs, but that such moves would harm profitability and therefore have been fought by the industry.

“Such actions would also end the billions of dollar a year in subsidy that the government provides to the money-market fund industry due to what is euphemistically called an implicit backstop,” Hall wrote in the SEC in a recent comment letter. “The subsidy is de facto government insurance, really just free money handed to the biggest mutual-fund companies in the U.S..”