Tuesday, January 11, 2011

Money Market Deja Vu

Almost one year ago, I wrote about the deception of money market funds.  Money market funds were under serious scrutiny then, because their manipulated price of $1 makes them appear to be less risky than they really are.  One year ago, the mutual fund industry refused the idea of letting money market funds vary around $1.  Why reveal that these investments that look like bank deposits actually have risk?

Today, the Investment Company Institute came back with a new suggestion: Set up a new "bank" that stands prepared to buy assets from money market funds when they cannot meet the liquidity demands of their investors.  Again, we're talking about making a risky investment look not risky.

Why is this called a bank??  Two very good reasons.  First, money market funds aren't bank deposits.  Bank deposits are secured, at least in theory, by FDIC insurance.  So, if money market funds could say their investments are "protected by a bank" it will make them sound less risky, right?  Second reason to call this "beast" a bank?  This beast is a financial guaranty company, and if there's one thing we've learned from the financial crisis, it is that financial guaranty companies don't work in a time of massive systematic shock!  (Here I talk about this problem more generally.)  So, let's call it a bank instead of an insurance company.

However, the real question remains: Why would we, the public, want to establish a financial institution that cannot possibly cover its own risks in a serious financial crisis, so that the mutual fund industry can more effectively hide the risk of money market funds?

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