Regulate Banks More Tightly, not Money Market Funds

I think that the powers that be do not like a low-cost superior source of liquidity that is outside of the banking system.  Why else would there be such regulatory pressure against money market funds, when their losses over their existence would be less than .o1% of yield?  Let the banks compete there… they have lost far, far more.  Which is more badly regulated?

Besides there are simpler ways to fix the problem without adding new charges or bureaucracy.  Let money funds invest as they will, and loosen their credit and maturity constraints.  They would earn better yields on average, and credit events would become a normal aspect of money market funds.  That would bring discipline to the market in a way that regulators rarely bring.  Funds that have credit events would be avoided by investors, but there would be no death spirals, because a run on the fund would improve the NAV.

Money market funds have several advantages over banks:

1. Their assets are short, like their liabilities.  Unlike banks the cash flow mismatch is small.
2. Their assets are high-quality.
3. Their assets are liquid.

As far as depositors go, it would be reasonable to abolish banks, and replace them with money market funds.  Wait, what will happen to the lending market?  That would be replaced by new institutions that borrow longer-term to finance longer-term loans.  It wold be similar to having a small bank sector and a huge REIT sector.  We wouldn’t care if these institutions went bust — they don’t take deposits.  What is better, by separating long-term finance from deposits, we would eliminate that source of most panics, because they occur when short-term liabilities finance long-term assets.  Solve the mismatch, and crises diminish.  Growth may be slower in the short run, but should be the same in the long run.

Forget deposit insurance for money market funds.  My solution is cheaper, simpler, and would allow for greater flexibility of fund management.  Let the banks justify their existence, and raise their FDIC premiums to a fair level.  After that, let the criticisms of money market funds begin.

Articles not cited: Should Investors Worry About Money Funds?

Why Investors Should Worry About Money Funds

Why Investors Shouldn’t Worry About Money Funds (good article, but ignore the dumb idea of insuring money market funds, they are safe enough already)

PS — the banking lobby is so much more powerful than the money market funds — it is no surprise that the banks win here.  We would all be better off if we eliminated the power of banks to take deposits, and handed it over to money market funds.  Of course the Fed would scream, because their power would be emasculated.  All the better.

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