Overhaul Targets Money Market
Plan Also Limits Hedge Funds

By Elizabeth Razzi
Special to The Washington Post
Sunday, March 29, 2009

The broad regulatory overhaul outlined by Treasury Secretary Timothy F. Geithner last week is aimed at restoring confidence in the financial system, reducing the chances that people unknowingly invest in high-risk securities and boosting investors' protections from scam artists like Bernard L. Madoff. The effectiveness of the measures will probably depend on their final wording after Congress, regulators and the industry get through hashing out the details.

For individual investors, a few features are discernible based on the details released so far.

Money-market mutual funds are likely to be better protected against runs and panics.

Hedge funds will become cats with bells around their necks, much less likely to hide in, say, a too-big-to-fail insurance company called AIG.

The investment advisers and broker-dealers who handle your money are probably in for more scrutiny and tougher enforcement.

Money-market funds, in particular, were highlighted in the plan Geithner outlined last week. Investors have traditionally seen money-market funds as safe places to park cash, with a higher return than an insured bank account, without having to lock up the money for a long time. If you put in a dollar, you could always withdraw your dollar.

But when Lehman Brothers went into bankruptcy in September, the ripple effects caused one large money-market fund, Reserve Primary Fund, to "break the buck," meaning its net asset value dipped below one dollar a share and investors would lose some of their principal.

That sparked a run on money-market funds. "All of a sudden, there was risk where people had assumed risk not to exist," said Liz Ann Sonders, chief investment analyst for Charles Schwab.

The Treasury Department squelched the run by announcing a temporary guaranty program to cover money that people already had on deposit with money-market funds. More than 1,900 funds have chosen to participate in the Treasury's voluntary program.

The run may have been stopped, but the underlying risk still hasn't been addressed. The Treasury's protection covers only money that was already on deposit as of Sept. 19, 2008, and the program is set to expire on April 30. A Treasury spokesman said the department is considering an extension through Sept. 18.

Although money-market funds are already regulated by the Securities and Exchange Commission, Geithner has proposed that those regulations be strengthened to reduce the credit and liquidity risk of the funds.

The industry itself is advocating changes that would boost the liquidity and credit of money-market funds. Earlier this month, the Investment Company Institute's money-market working group recommended boosting funds' liquidity -- their ability to turn assets into cash -- by requiring that at least 5 percent of a fund's net assets be held in securities that can be tapped within one day, and that at least 20 percent of its net assets could be turned into cash within seven days. The group also advocated new measures to analyze the real credit risks of new investments held by money-market funds.

Some analysts expressed concern about the uncertainties involved with the government launching far-reaching "new rules of the road," as Geithner called his proposals.

Regulatory overreach is a concern, said Schwab's Sonders. "History is littered with post-crisis regulations," she said. "If there are undue restrictions on the operations of businesses, they may view it to be their job to get around them, and you sow the seeds of the next crisis."

But perhaps a regime of simpler and better-enforced rules would help coax investors back into investing some of the cash they have stockpiled on the sidelines. The stock market's rally over the past three weeks has tempted some money back into stocks, but investors' crisis of confidence has not yet lifted, Sonders said.

"It's better than it was last fall, but is it fully repaired? No," she said, "not even close. There's a fear factor in this environment that truly is unprecedented, because the land mines appear to be everywhere."

Michael Herbst, a mutual fund analyst with the Morningstar investment research company, said the industry could benefit from greater transparency regarding riskier financial instruments such as derivatives and credit-default swaps.

"It would enable the individual investor and adviser to make better-informed decisions," he said.

But he warned that overhauling the rules is not without risk. "If the government appears too heavy-handed or uninformed, they could actually spook investors worse."