August 7, 2009
The majority of File No. S7-11-09, while dangerous because it invites more national government control over the already burdened economy, contains reasonable and, in themselves, useful changes. The new proposals are good proposals.
However, the possibility of a floating net asset value is far less desirable. The SEC is right to point out the possible pitfalls when large amounts are invested within the possible variation around $1.00. It also correctly notes that the Money Market system contains a built-in incentive to withdraw early in a financial crisis.
The problems lies in the consequences of the change. Allowing a floating NAV will create significant instability within money market funds. Short-term traders will use the variation in price to make short term trades, which both introduces undesirable variation in the fund values and creates an unpredictable cash situation for fund managers.
Worse, the current floating NAV will not eliminate the risks it is intended to control. The SEC itself says in the request for comment (page 32717), "We recognize that a floating net asset value would not necessarily eliminate the incentive to redeem shares during a liquidity crisis." The changes can only have a limited effect on risk of "runs" on money market funds.
In addition, the changes will not, in any substantive way, reduce risk. The SEC and money market funds are right to warn investors of the inherent risks of the money market system. Net asset values are intended to be kept at $1.00 but not guaranteed. All investors in money market funds are, and ought to be, informed of this risk. Allowing a floating NAV only changes the risk the investors are already aware of. If investors are not as fully aware of the risks as would be desired, the change should be to provide more information, not to alter the system.
The ultimate result of a floating NAV is that money market funds will act no differently than short (or ultra-short) term bond funds. Shares will be traded on a moving prices, with investors free (and encouraged) to enter and withdraw from a fund based on its share price. Not only does floating NAV fail to effectively decrease the risks it is intended to control, it also introduces more volatility to the cash flow and stability of the system. In sum, a floating NAV will destroy the money market system and eliminate one of the most useful and heavily used financial instruments available.