EVENTS

Date:	Tuesday, May 5, 2009
Time:	10:00 AM -- 12:00 PM
Location:	Wohlstetter Conference Center, Twelfth Floor, AEI 1150 Seventeenth Street, N.W., Washington, D.C. 20036

WASHINGTON, MAY 8, 2009--When financial markets headed down last year, many investors fled to safety. At first they fled to money market mutual funds, considered so safe that they are legally considered "cash equivalent." Then, on September 16, 2008, one day after the collapse of Lehman Brothers, the money market Reserve Primary Fund became only the second in U.S. history to "break the buck" and suspend redemptions. The breakdown caused a run on the money market, and the Treasury offered to insure money market accounts opened prior to the Primary Fund collapse. The Treasury's protection ends later this year, but some believe that the bailout will have lasting consequences.

"We have permanent implied money market insurance. It's with us now and it's likely to be with us forever," Mercer Bullard of the University of Mississippi and Fund Democracy said at an AEI conference on money market funds on May 5. He noted that raising the Federal Deposit Insurance Corporation's protection to $250,000 increases government obligations to the banking sector and may in fact be riskier.

AEI's Peter J. Wallison disagreed, arguing that the Treasury program will end with little impact. "We are going to return to the status quo ante; money market funds will be seen as uninsured," he said. According to Wallison, Primary Fund problems only affected other funds because of extremely rare market conditions. Had markets been properly functioning, breaking the buck would only have harmed the mismanaged firm, not the whole sector. While the government has intervened in a number of cases, by allowing Lehman Brothers to fail the government made market participants doubt that it would act to save other failing institutions.

Concerns about increased risk in the money market, real or perceived, have some calling for new rules. Brian Reid, the chief economist for the Investment Company Institute (ICI), an industry organization, presented finding from ICI's Money Market Working Group recommending new disclosure requirements, shorter maturities, and new liquidity standards. Reid said that these provisions can be conducted by firms with expansions of the current regulatory framework and without government insurance.

The ICI report favors these solutions to alternatives like floating net asset valuations. Under current rules, money market funds are allowed to round their net asset value (NAV) to one dollar as long as it stays in a small range. When funds exit that range, they "break the buck." Under a floating NAV, the fund's value would fluctuate. Reid explained that floating NAV investments, such as ultra-short bond funds, already exist but that demand remains low.

Eugene Maloney of investment management firm Federated Investors agreed that floating NAVs and other reforms--such as capital requirements--that make money market funds more like banks should be discouraged. He counseled that "imprudent regulation" could put money market funds out of business. Maloney agreed with Wallison that the conditions that caused the Primary Fund to break the buck are extremely rare. "Money markets funds did not create the financial crisis," he said. "They were victims of it."

The ICI report concludes that the market conditions seen last year are rare. The report calls for modest improvements to existing regulations rather than a regulatory overhaul. During the discussion period following the panel, one questioner compared the Treasury's insurance to the government's relationship to Fannie Mae and Freddie Mac; the government said it would not protect these firms, but it did when they faltered. Comparing the two scenarios, Wallison, who has written extensively about the GSEs, explained that expectations matter. "Nobody knows," he said. "If we act like money market funds are protected by the government, they may in fact become backed by the government."

--ADAM PAUL

• Video, audio, and event materials