Courtesy of Doug Short.
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“The world is all gates, all opportunities, strings of tension waiting to be struck.” – Ralph Waldo Emerson
This past week was inundated with a variety of financial and geopolitical events that had me scrambling to say abreast of the issues. However, there was one issue in particular that was obscured by the news flow of MH-17 and Israel, a ruling by the S.E.C. to put “gates” on mutual fund redemptions.
“This past Wednesday, the Securities and Exchange Commission voted 3-2 to require institutional money market mutual funds to adopt a floating net asset value. The SEC also imposed liquidity fees and redemption gates, changes that muni market groups have said will hurt the market as well as state and local governments. The redemption gates are discretionary and there are potential liquidity fees of up to 2% if a MMF’s level of weekly liquid assets falls below 30% of its total assets. It is up to each individual fund’s controlling board to impose a fee or restrict redemptions in times of stress, giving the board time to figure out a way to meet those redemptions.”
After mentioning this topic on “The Lance Roberts Show,” I was flooded with emails and questions about the potential unintended consequences of such a ruling.
I penned some brief thoughts on the issue in yesterday’s post “3 Things To Think About.” However, there were several articles worth reading on the issue to gain a more balanced viewpoint on the potential consequences and risks of the recent ruling.
1) The “Gates” Are Closing via ZeroHedge
“Redemption gates are the ‘wrong tool to address risk,’ said SEC Commissioner Kara Stein during open meeting.
Fear incentives will result in “greater chance of fire sales in times of stress and spread panic to other parts of the financial system while denying investors and issuers access to capital.
- ‘Money market funds are only one part of wholesale funding markets that need to be strengthened.’
- In the event the gate imposed increases, investors have a ‘strong incentive to redeem ahead of others.’
- While a gate may be good for one fund, ‘it can be very damaging to the financial system as a whole.’
- When the gate for a fund is used, it doesn’t mean the ‘impact on wholesale funding markets will be prevented.’”
She is spot on. But forget about our opinion, or even that of the SEC, because while on the surface this now enacted proposal to establish withdrawal limits is spun as benign, it was the Fed itself who warned in April of 2014 that ‘the possibility of suspending convertibility, including the imposition of gates or fees for redemptions, can create runs that would not otherwise occur… Rules that provide intermediaries, such as MMFs, the ability to restrict redemptions when liquidity falls short may threaten financial stability by setting up the possibility of preemptive runs.'”
2) US Approves Money Market Reforms by Gina Chon and Stephen Foley via FT
“Funds targeted at retail investors will be exempt from the floating share price, but the rule catches all institutional funds except those investing only in federal government securities. The industry has long expected that the $900bn in so-called prime funds, which invest in short-term corporate debt, would be affected, but the reform also catches $70bn in municipal debt funds, potentially raising borrowing costs for US cities and states.
‘The [rule] impedes one of the commission’s stated goals of this reform effort – ‘preserving, as much as possible, the benefits of money market funds,’ said commissioner Michael Piwowar, who objected to the floating rate. ‘Therefore, the continued utility of institutional prime and tax exempt money market funds as a cash management tool is highly questionable.'”
3) Property Rights Of Money Market Funds Weaken by Pater Tenebrarum via Acting Man
“The floating requirement obviously favors the banking industry over money market funds, as these funds have been used by investors as a cash equivalent, bringing a slightly higher return than could be had from a bank deposit. Once their unit prices begin to float, they will no longer be seen as cash equivalents, so banks will enjoy an advantage.
This advantage is unfair, because bank deposits are by no means safer. On the contrary, since they are fractionally reserved and the assets ‘backing’ them often have far longer maturities than the short term debt money market funds as a rule invest in, they must be regarded as inherently more risky.
However, the main problem is the proposal to erect ‘redemption gates’. First of all, the Fed was not ‘forced’ to bail out the industry by backstopping it (note that banks are similarly backstopped by the Fed, and this is apparently not questioned at all). The Fed did of course backstop money market funds, but to argue that it was ‘forced’ to do this is a huge stretch. According to which statute was it forced? Given that the Fed’s policies caused the bubble that eventually imploded and created trouble for money market funds in 2008, one could of course well argue that it had some moral responsibility to help them. It goes without saying though that the world would be better off without bubble-blowing central banks, as then no rescue operations of this sort would need to be pondered in the first place.
The adoption of ‘redemption gates’ effectively means that money market fund boards will be able to suspend the property rights of their customers. Once again, this creates a big disadvantage for the money market fund industry in favor of banks, since demand deposits will continue to lack such ‘redemption gates’, in spite of the fact that banks are de facto unable to actually pay out all demand deposits, or even a large portion of them, ‘on demand’.
It is an interesting detail that retail customers are to be exempt from this regulation based on the idea that they are basically too addled to react to crisis conditions. Why are such regulations held to be required at all? Are regulators implying that the system has not been ‘made safe’ by adopting several telephone book-sized tomes of additional regulations?”
4) SEC Adopts New Money Market Rules by Kyle Glazier via The Bond Buyer
“Groups such as the National Association of State Treasurers and Government Finance Officers Association have said that municipalities use MMFs as vehicles for short-term cash-flow management, which wouldn’t be feasible under a floating NAV.
The groups have also said that local government investment pools will be damaged by the reforms. LGIPs operate in several states to help municipalities invest public funds safely and efficiently. They are designed to provide short-term investments for funds that are needed by governmental entities on a short-term basis. They operate like money market funds, but their clients are local governments. They are indirectly regulated by the SEC because the Governmental Accounting Standards Board mandates that money market-like funds be governed by money market fund rules.”
5) Housing Contradictions by Jeffrey Snider via Alhambra Partners
“In contrast to existing home sales there has been no real bounce in new home sales. Again, that more than contradicts the idea of a home shortage (or at least a true market shortage, there may be a shortage when only factoring monetary targets) and further explains why builders are reluctant to close the purported supply gap. It makes no sense to build new dwellings at a faster pace when there has been no real change in the demand for them; worse than that, the latest readings on demand point slightly downward.”
“What is perhaps more important overall is how definitively new home sales are at odds with existing sales. That isn’t necessarily significant by itself, but in the context of what I was trying to describe a few days ago I think this fits the idea of “froth.” In other words, there is an artificial element to the real estate market, evident once more even to a smaller degree in May and June, that is pumping the “market” for existing sales without having a direct boost in new home sales – and thus construction.”
READ ALSO: Beware Of False Dawns by Ed Yardeni
The “If There Is Nothing On TV” Bonus
Michael Mauboussin speaking to Google about “The Success Equation: Untangling Skill And Luck.”
Importantly, about 7 minutes into the presentation he discusses “reversion to the mean.” He makes a fascinating point that:
“While people have a sense of what it means, they do not act as if they know what it means.
Simply, an event with an outcome that is far from average will be followed by an outcome that is closer to the average.”
Have a great weekend.
Originally posted at Lance’s blog: STA Wealth Management
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