Money Market Fraud? No, Fund!

Suppose you had a risky investment that fluctuated in value all day, every day. Also, suppose you wanted to use this investment like a checking account, but you really didn't like all that "bouncing around" of the investment's value.  Wouldn't it be cool if you could just pretend it didn't bounce around?  I mean, who ever got hurt by hiding a little risk, ignoring a little volatility, or putting fake prices on illiquid securities, right?

In a nutshell, I just described your money market fund.  The SEC announced their reform plan today. Among other things, they allegedly "considered" moving to a floating net asset value.  Surprise!  All the comments from investment companies opposed this change.  Imagine that! The companies who's business depends on convincing the public that their risky portfolios have no risk because every day they're allowed to manufacture a share price of $1.00, (unless a disaster strikes, of course!) opposed changes that would have required them to let you see the risk!!  I know, crazy, right?

Money market funds aren't the only problem, just a very large problem.  Have you heard of GICs?  Guaranteed Investment Contracts.  You may have them in your 401(k) plan.  Guess what?  They're not guaranteed by anyone but the insurance company that sold them to you!  Investors like to see interest payments in their retirement plans.  They don't like to see changes in the value of their bond portfolios.  (Remember, when interest rates move up, the value of your fixed rate bonds moves down.)

So, Insurance companies provide wrappers that "guarantee" interest payments on a fixed principal. That's a GIC.  You start with a bond portfolio with moderate maturities that pays interest, but will vary in asset value (because bonds do mark to market all the time!) In it's place, the insurance company hides the volatility by guaranteeing you a slightly lower return, (hey, they gotta make a living!)  So what's the downside?  You start with diversified credit risk.  You end up with un-diversified credit risk, and lower returns because if the insurance company goes bust, you lose.

Financial innovators and regulators hide risk very well.  They can't make it go away.