Money Market Funds: 'Chutzpah Banking'

Includes: IAT, KBE, KRE, PJB, RKH
by: Vernon Hill

Back in the 1970s, when passbook savings rates were regulated (and set well below market rates) a new beast arose to fill the role bank savings accounts once played: the money market mutual fund. These were pools of highly liquid funds, reportedly invested in short-term vehicles, that paid competitive savings yields. They were marketed as being 100% liquid and just as safe as bank deposits.

But the funds didn’t have to operate under the burden of FDIC supervision. Partly because of this, and the higher yields they offered, they were able to suck massive amounts of funds from banking system--and weakened it tremendously, in the process. The funds’ corporate parents, meanwhile, promised that even though the funds weren’t guaranteed by federal deposit insurance, investors were not at risk of principal loss.

Money market funds boomed, and eventually became a cornerstone of the “shadow banking system.” Like most things shadowy, this alternative system wasn't entirely what it seemed. In the last few days, we’ve all found that out: investors have indeed lost principal, several major funds have closed outright, and the funds’ corporate parents have not stepped in to protect investors’ principal.

So much for shadow banking. Or maybe they should call it “chutzpah banking:” now, in the fund operators’ time of crisis, and even though the operators haven’t paid a nickel’s worth in FDIC insurance premiums and have avoided the restrictions of federal regulation (and haven’t had any “socially responsible” missions foisted on them by Congress), the money fund companies have gone hat in hand looking for a federal bailout.

And lo and behold, they’ve gotten one. The federal government has guaranteed 100% of the funds’ principal, in effect providing the fund operators the same protection, for free, that the banking industry has had to pay the FDIC for for years.

When are you bankers going to rise up and put an end to this nonsense? You’ve stood by for years and let outsiders fritter away your franchise:

  • The investment banks have skimmed off high margin business, using massive leverage.
  • The money market funds siphoned massive amounts of our deposits—and have even gotten the government to provide a guarantee.
  • Congress gives us to unending social mandates, such as the Community Reinvestment Act and flood insurance, that provide low (or negative) returns.
  • The regulators are capricious and impose costly burdens.
  • When a crisis finally hits, the feds bailout our unregulated competitors at no cost.
  • Our lobbyists, led by the ABA, turn out to be spineless and ineffectual.

The current crisis gives bankers a huge opportunity. How can we use it to strengthen our banking system, and fortify our core franchise?