It is What it is But it isn’t What it Ain’t

I recently had the pleasure of going to the upper peninsula of Michigan for a family vacation (that’s the UP to those in the know). During this vacation, I attempted on several occasions to make the acquaintance of the local fish population. I also found myself in various laundry mats from time to time washing our grubby clothing. These two points are connected by the fact that I had nothing to do but surf the net while I watched the clothes spin around, and I used that time to try and figure out why I wasn’t meeting any fish.

I learned a few things. First, like all fishing outings, I should’ve been there the day before when they were really catching them. Second, while there are still plenty of fish in the Great Lakes, it’s not like it was back in the day (that day being any time prior to the 1950’s).

What changed? Well, with a desire to improve the regional economy, canals and other related works were undertaken to open the Great Lakes to the Atlantic Ocean for shipping. So far, so good. What wasn’t factored in was the superhighway that had now been created for a very nasty parasite known as the sea lamprey.

With no natural predators within the Great Lakes ecosystem, the sea lamprey thrived while the trout they killed by the millions basically disappeared. In an effort to combat the devastating loss of the fishery, salmon were introduced. In the absence of the trout, and with the use of a chemical solution that keeps the sea lamprey down, the salmon flourished – at least for a while. Some of the Great Lakes have now experienced massive collapses in their salmon populations as the non-native fish have overwhelmed the available food supply. Throw in the havoc wreaked by the invasive zebra mussel and you’ve plenty to ponder for at least four loads of laundry.

As I pondered this mess I received an e-mail that announced that the SEC finally got around to implementing their much-discussed reforms to the money market fund industry. No, at first blush there doesn’t seem to be a lot in common between a battle to save a fishery and money market funds. Please hear me out.

We enjoyed a long stretch of time (25+ years) where we had ready access to what we believed to be a risk-free return in the form of money market funds. This particular bubble burst when The Reserve Primary Fund broke the buck back in September of 2008. The government and regulators quickly stepped in to prevent a mass exodus from money market funds.

Much hand-wringing took place on the part of regulators, money market managers and, in particular, investors. How could this have happened to something believed to be a long-time, rock-solid investment vehicle?

What many don’t realize is that the existence of money market funds represents just a few minutes of the proverbial financial clock. Before there was salmon, and sea lampreys, there was trout. Before money market funds, there were interest-paying bank deposit accounts. Money market funds came into prominence because they provided a way for investors to reap a higher yield than what was available via bank deposits (which were capped until the mid-1980s by the Federal Reserve Board’s Regulation Q).

The SEC’s recently announced changes involve amendments to rule 2a-7, which regulates money market funds. Rule 2a-7, and money market funds as we know them, didn’t exist until 1983. This rule was a significant event as it gave money market funds: 1) the unique ability to value their shares at $1 and not their actual market value, 2) when first enacted, it provided the aforementioned ability to reap higher returns vs. bank deposits, and 3) it gave investors the notion that the high-quality investment standards also required equated to some sort of government-backed guarantee.

Money market funds, like the lake trout, did indeed have a good long run. Runs do inevitably end, and it’s also worth noting that this latest reform is the second round undertaken since the 2008 crash. The first round of reforms back in 2010 came on the heels of a confidence band-aid known as the Treasury Guarantee Program for Money Market Funds which I’ve previously had a little fun examining.

All of this reform has come at a time when yields in the money market fund universe have dropped to essentially zero. As previously discussed, rates would actually be less than zero should the folks managing the money market fund actually assess their management fee.

Where does this leave us? A number of money market funds already post their actual daily asset values. Floating NAV money market funds have been in place for several years in Europe. As this latest reform essentially only involves about a third of the money market universe (prime funds) and will be phased in over two years it is hard to predict what impact this will have – particularly with the dearth of available options for those looking for what they believe to be a risk-free rate of return.

Whether it’s fisheries or financial markets, the only thing you can truly count on it change. While I don’t believe that the money market reforms will have canal-like unintended consequences, rules continuously get amended because markets and investors don’t behave as expected. As the Wood Brothers so eloquently put it, “It is what it is but it isn’t what it ain’t. Doesn’t matter what it was cause you know it’s gonna keep on.”

*Originally published August 2014.

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