AMAC Exclusive – By David Lewis Schaefer
While President Joe Biden and his PR team tout the supposed successes of “Bidenomics,” his regulatory appointees at the Securities and Exchange Commission (SEC) are creating more obstacles to real economic growth, hampering the ability of everyday investors to overcome losses from inflation.
Last week, a vote by the SEC Commissioners established a new policy requiring money market funds (MMFs) to hold at least 25 percent of their assets in “daily liquid assets” and 50 percent of their assets in “weekly liquid assets,” as opposed to the current requirements of 10 percent and 30 percent, respectively. The vote on the change was the Commission’s three Democrats in favor and two Republicans against (the five SEC Commissioners are all appointed by the president, with the requirement that no more than three members can be from the same political party).
In contrast to huge losses and volatility in the stock and bond markets, MMFs have provided safe and steady gains for the typical saver over the past year, averaging around a five percent return. In total, MMFs currently hold nearly $6 trillion in assets, and are characterized by short maturities and minimal credit risk.
SEC chair Gary Gensler acknowledged in announcing the new policy that MMFs “provide millions of Americans with a deposit alternative to traditional bank accounts.” He might have also added that MMFs typically provide a combination of higher interest and greater flexibility than bank certificates of deposit offer.
Yet MMFs, invented over a half-century ago, also offer a degree of safety that is very close to what federally insured bank accounts offer, and quite likely higher than bank deposits that exceed the limit of federal insurance.
MMFs do this by investing in short-term loans, including government bonds, currently (in the case of one of the largest such funds, Vanguard Government Money Market Fund) with an average weighted duration of 46 days. “Weighted” here means based on the amount allocated to different investments as opposed to a mere average of all investments regardless of their size. The funds are required to invest solely in the highest (AAA) rated securities.
The short duration of the MMFs’ holdings largely guarantees their ability to maintain a constant share value of one dollar, regardless of market developments – since a rise in overall interest rates is rapidly reflected in the rates paid on the funds’ holdings. (This is in contrast with longer-term bond funds, whose value will vary with rate changes.)
Rarely has a MMF ever been on the verge of “breaking the buck;” that is, proving unable to redeem shares at their one-dollar value. When this threat arises, the large fund families sponsoring such funds normally intervene to preserve their value.
When general interest rates were low, MMF returns, like those of bank CD’s, were correspondingly low, and fewer investors chose to place their savings in them. The opposite is the case today.
But the funds’ record of safety isn’t enough to satisfy Chairman Gensler and his Democrat colleagues. Supposedly in order to insure against the danger of a “run” on MMFs, in which the funds prove unable to redeem shares at their par value, Gensler & Co. want to shorten the average maturity of their assets.
By way of contrast to the SEC’s new rule, the Vanguard Government Securities Money Market Fund, not only one of the largest MMFs (and part of one of the largest fund families), as of July 18 held 145 securities, with an average weighted maturity of 46 days. In other words, in order to comply with the SEC’s new rule, the fund will have to reduce the average maturity of its holdings and put one-quarter of its funds into “assets” that have a maturity of just a day – merely overnight loans – and half the assets into securities that mature within a week.
But since overnight loans pay only minuscule interest, and even those with a week’s duration pay relatively little, the result will be a significant decline in the fund’s earnings, and hence the dividends it pays its shareholders.
The effect is no different from an additional tax on shareholders’ earnings. Ordinary investors will make less, while their money will in effect be less secure as diminished returns and ongoing inflation eat into it.
The SEC’s new rule is ostensibly designed to avert the danger of an MMF “breaking the buck” – that is, being unable to maintain its share value as a result of a sudden rush of investors attempting to withdraw their money at a rate faster than the fund can earn interest to cover them.
But this is an event that has occurred very rarely. In the history of the money market, dating back to 1971, less than a handful of funds broke the buck until the 2008 financial crisis. In 1994, a small MMF that invested in adjustable-rate securities got caught when interest rates increased and paid out only 96 cents for every dollar invested. But as this was an institutional fund, no individual investor lost money, and altogether 37 years passed without a single individual investor losing a cent.
Only in 2008, the day after the Lehman Brothers investment firm filed for bankruptcy, did one MMF fall to 97 cents after writing off the debt it owned that was issued by Lehman. This created the potential for a bank run in money markets, as there was fear that more funds would break the buck.
Shortly thereafter, another fund announced that it was liquidating due to redemptions, but the next day the United States Treasury announced a program to insure the holdings of publicly offered money market funds so that if a covered fund were to break the buck, investors would be protected to ensure the continuing $1 net asset value of their holdings.
It cannot be denied, then, that money-market funds – especially smaller ones that aren’t part of large fund families – pose a slightly higher risk than bank accounts do. (That risk is practically nonexistent in the case of funds that invest solely in federal securities, like the Vanguard fund.) On the other hand, however, in times like these, they offer the potential for significantly higher return – not enough to outpace high inflation plus income taxes, but still a lot more than one can earn on a one-year bank CD (national average as of July 18, about 1.25 per cent).
MMFs by law must emphasize to potential investors that they aren’t government-insured, and therefore cannot be guaranteed never to lose share value. But against that (nearly minuscule) risk must be balanced the real prospect of interest-rate risk: the danger that the value of one’s savings will be considerably eroded if the only place to put them, assuming one is a very conservative investor (say, a retiree) is several points below the rate of inflation.
Nearly all money-market investors can be counted on to be aware of the risks as well as the potential rewards of their investments, and to plan accordingly. Mr. Gensler and his allies, however, want to protect them against themselves – at the risk of reducing the earnings from their savings.
If anything, the new SEC rule – combined with other similarly ill-formed regulations announced at the same time as the new rules on asset allocation – may drive savers into more risky investments (stocks, bonds, real estate) just to compensate for the reduced interest that MMFs are now able to pay them. The beneficiaries, if any, of such a switch will be the high-flyers who can afford to take such risks (especially younger investors, whose time horizon lets them ride out market swings in a way that those in or nearing retirement cannot).
Gensler’s new policy exemplifies the sort of “tutelary” despotism that Alexis de Tocqueville feared, in which government, with the most benign intentions, seeks to remove from citizens the power of making significant choices, lest they violate the knowledge of “experts.”
Americans would be better off if Democrat regulators at the SEC (or Lina Khan, the activist chair of the Federal Trade Commission, who has abandoned the traditional consumer-welfare standard for assessing corporate mergers in favor of an all-out-war on mergers that offend her sensibilities), simply left them alone, except in the case of genuine dangers.
President Biden, how about passing this lesson along to them?
David Lewis Schaefer is a Professor Emeritus of Political Science at College of the Holy Cross.
