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Money market funds were once considered bastions of safety—until the failure of Lehman Brothers in 2008, when one major player “broke the buck” and lost a few pennies per share, setting off a financial market panic. These days there’s animated debate about whether it’s time for the $2.6 trillion business to abandon the practice of fixing share prices at $1 and allow them to fluctuate.
Fidelity, the largest manager of money funds, says eliminating the fixed share price would “destroy” the industry. Federated Investors (FII), Vanguard, and the fund industry’s main trade group have issued similar warning. BlackRock (BLK), the seventh-biggest player, has a less dire view. “We think there will be some shrinkage, but we don’t think it would eliminate the product,” says Barbara Novick, BlackRock’s co-founder and vice chairman.
Money funds, first offered in 1971, have become a big part of the shadow banking system, taking deposits while lending to companies, banks, and government entities, all outside the reach of banking regulations. They can offer customers higher rates than many bank savings accounts because they don’t have to pay for federal insurance or set aside capital to cover losses. They also don’t have to value holdings at market prices, because the short-term debt they buy rarely defaults. That means they can keep share prices fixed at $1, allowing customers to make deposits and withdrawals without worrying about fluctuations in their accounts’ value, not unlike a regular bank account.
Few questioned those premises until September 2008, when the $62.5 billion Reserve Primary Fund, which owned $785 million of Lehman Brothers’ commercial paper, collapsed, setting off an industrywide run that helped freeze global credit markets. The panic abated only after the Treasury guaranteed money fund shareholders against losses for a year.
Congress has banned the Treasury from repeating such a bailout, and regulators are looking for ways to prevent another run. The Securities and Exchange Commission is expected to propose this month that funds value their holdings at market prices and let their share prices fluctuate. Regulators argue that a stable share price, or net asset value (NAV), encourages investors to flee at any hint of trouble, because they can pull out at $1 a share until a fund’s board gets around to writing down the value of a troubled security, as happened with Reserve Primary. If share prices fluctuated, they would immediately reflect changes in the value of the fund’s portfolio, giving investors no opportunity to cash out at an artificially high price. Fund companies have long rejected that idea, saying their investors would still abandon a suspect fund. A floating NAV would also introduce a host of bookkeeping and tax headaches for funds and investors, they say.
BlackRock is trying to play conciliator. It has suggested a plan for a floating NAV that would exempt funds that invest only in government-backed securities—such funds account for a third of money fund assets. Other money funds would have to apply market prices only to securities more than 60 days from maturity. BlackRock also is calling on the Internal Revenue Service not to treat small gains and losses as taxable events for money fund investors. While regulators and other fund companies have not commented on the plan, BlackRock says the industry would be wise to follow its lead. “The regulators are going down this path,” says Novick. “Do you want to fight them or try to work for the best possible solution?”
The bottom line: BlackRock has broken ranks with its peers in the money fund industry over the sanctity of the fixed $1 share price.