US Outlook We stared into the financial abyss in September 2008. You probably recall the pictures from that week after Lehman Brothers collapsed: suddenly-jobless bankers taking their office nick-nacks away in boxes; worried regulators shuttling between the Federal Reserve and offices of the imploding insurance giant AIG.
Lehman and AIG are the potent symbols of the meltdown, but they were not the worst of it. The worst thing that happened that week in 2008 was a run on money market funds, investment vehicles that housed over $2 trillion on behalf of everyone from ordinary savers to the biggest corporations in the world. If the US government had not stepped in, the run would have destroyed those funds, savings accounts would have been wiped out and companies would not have been able to pay their workers.
And we have done nothing to stop it happening again.
This is the last scandal of the credit crisis, that politicians and regulators walk on by despite knowing that a crucial part of the financial system is fundamentally unsound.
Money markets pretend to be as safe as bank accounts, and they are used just like bank accounts by ordinary Americans and corporate treasuries alike. Unlike most investment funds, you can get your money out at any moment. They invest only in very short term corporate debt, in effect funding the working capital and payroll needs of some of the world's biggest employers. They are big, short-term lenders to the banking system, too, further increasing their systemic importance.
Because money market fund assets are typically very short term debt – lending to corporations with good credit ratings, usually for just a matter of weeks or days – the risks were supposedly close to zero. The scales fell from our eyes in September 2008 because one of the best-respected funds turned out to have lost money on Lehman debt. After discovering that, panicking investors pulled out $369bn, or 17.9 per cent of all the money in all the funds, in the space of just four days. The US government stopped the run only with the astonishing (and astonishingly dangerous) announcement that it would guarantee all the funds, temporarily establishing the kind of rock-solid guarantee that bank accounts get and which banks are required to pay for via a levy to the Federal Deposit Insurance Corporation. That guarantee has now ended – formally – but of course everyone knows the taxpayer will have to stand behind these funds again next time, too.
The Securities and Exchange Commission, the industry regulator, has been struggling to come up with even modest reforms. Its proposed approach is two-pronged. On the one hand, funds are being required to be even more conservative in their investments. On the other, investors in the funds are being told that they will no longer be able to have immediate access to all their money.
These proposals have prompted a vicious push-back by money market funds' lobbyists. Politicians are being roused into opposition. The objectors argue that hurting the funds hurts corporate America, since it makes it harder for businesses to get financing. I also heard one Congressman argue that reform could push all this short-term funding activity back into the banking sector and into banks that are already "too big to fail". But that is actually a far safer place for this crucial part of the payments system. Banks are regulated and the problem of "too big to fail" is being tackled by the new Dodd-Frank laws. Politicians haven't shirked their responsibilities to deal with the banks, at least.
Britain's own HSBC is quietly shopping round a compromise proposal on Capitol Hill that doesn't limit what investors can pull out all at once but does impose a "liquidity fee" to make redemptions less attractive. That wouldn't matter a jot if panic sets in. Remember, investors were accepting negative yields on US Treasuries in the 2008 stampede, effectively paying the government to park their cash in the only safe asset around.
A much more honest solution, and the only one that could genuinely prevent a repeat of 2008, would be to effect a permanent government guarantee of money market funds and to charge for it – but that would wreck the economics of the industry.
The Investment Company Institute, the lobby group, says all the ideas on the table will "drive investors out of money-market funds and essentially kill the product". To which the right response is: good.