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Business forum: Floating rates won't aid money markets
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When you use your credit card, pay your taxes and make payments on your car, student or home loans, you are participating in our nation's vast, nearly $3 trillion money-market system. Banks, finance companies, states and municipalities and others use your pledges to make your payments as collateral to borrow money for short periods of time.
As the primary purchasers of these short-term IOUs, money-market funds play a central role in this process.
Money markets have worked remarkably well in their nearly 40 years of existence. But this system confronted a major disruption in September 2008, when the Reserve Primary Fund "broke the buck" -- that is, its investors were unable to redeem their shares of at least $1 for every $1 they put into the fund. It was the first time in the industry's history that a money fund open to all investors broke the buck.
This prompted a surge in money fund redemptions, as well as industry and regulatory efforts to reduce risk. While we have found much common ground in various proposals to improve on our industry, we are concerned with one under consideration that would replace the standard $1 price our industry uses to value money fund shares with one that would allow the price to float.
The money-market industry is built around the concept of a $1 net asset value (NAV) price for each fund share, which is easy for investors to understand and businesses to use for record-keeping, accounting and valuation purposes. You put $1 in, you get $1 out, plus in most cases a premium from the interest the money fund's investments earn.
A floating-rate NAV, on the other hand, would be adjusted daily to reflect the market value of all the underlying financial instruments in which the money fund invests. Because these instruments are short-term in nature, in most cases, this calculation would still be rounded to $1. But in times of severe market distress or euphoria, the value of these underlying assets could change enough to lower or raise the share price of a fund by a penny or more -- say to 99 cents or $1.01. That may not seem like much. But the problem is the pricing for fund shares would no longer be a predictable, stable $1 every day.
From a cash-management perspective, this would add to the difficulty and costs for the treasurer who relies on money funds to balance the books every day. From an investment perspective, this floating-rate pricing could exacerbate fluctuations in the daily share price, creating an unstable environment that is precisely what a $1 NAV seeks to avoid.
To be sure, professional money managers have a lot at stake in the outcome of this debate. A switch to a floating-rate NAV would likely force us to make significant adjustments to our business, which employs nearly 1,400.
But this truly isn't about just us. Money funds are critical to the U.S. economy and the financial markets, critical to corporations, small businesses, nonprofits and governments across the country, and critical to enterprises throughout Pittsburgh. The challenges in the wake of the Reserve Fund's breaking of the buck have led to an appropriate exploration of ways to improve the functioning of the money markets. But a fundamental change would be like opting for major surgery when a few minor procedures would do.
First Published February 5, 2011 12:00 am
