Capital Controls Back in Vogue
A rule change approved by the Securities & Exchange Commission (SEC) in 2014 comes into force this week, granting money market mutual funds a right they previously never had: to delay client withdrawals during times of economic distress.
The 2a-7 money reform rule was designed to prevent another Lehman Brothers-style disaster in the U.S. economy. When Lehman Brothers began to collapse, there was a mass exodus of capital from money market mutual funds, which caused a death spiral in the value of related assets. (Source: “The Day Has Arrived: As Of Today Prime Money Markets Can Suspend Withdrawals – Here Are The Implications,” Zero Hedge, October 14, 2016.)
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The ensuing financial crisis became a full-blown economic catastrophe for the world at large, something the SEC would rather avoid in the future. By amending the rules, they want money market mutual funds to float the net asset value of their holdings.
It would mean they are able to track significant risks to their solvency and ultimately empowers them to withhold client requests for withdrawals. The logic here is to clamp down on any possible contagion from an adverse market scenario.
Although the SEC is eager to characterize the rule change as pre-emptive crisis management, there are some analysts who worry it can set a dangerous precedent. Money market mutual funds are supposed to be highly liquid securities, ones that allow companies the freedom to park cash they intend to use in the short term. In many ways, they are similar to deposit accounts.
These types of mutual funds, also known as “prime” funds, are supposed to insulate capital from substantial shocks. They are supposed to preserve the principal amount of cash put in, while earning a tiny bit of interest to offset the losses created through inflation.
But significant downside risks are not supposed to be an issue. By amending the rules to lock in client funds, the SEC is tacitly admitting that contagion could affect these funds.
Many corporate treasurers are already re-routing their short-term holdings to non-prime funds, which offer slightly more interest. They have also been trading in assets for government securities.
Early reports show $1.0 trillion worth of funds has already moved out of CDs and into Treasuries. The transition is causing a spike in LIBOR rates, an effect that was unanticipated and could wreak havoc on a ton of debt around the world.
