Editorial: Force a showdown over money market funds

Sometimes when something walks like a duck and talks like a duck, it's not actually a duck. Sometimes it's a ticking time bomb.

Money market funds quack pretty much like banks, making their investors feel like depositors with check-writing privileges and share prices fixed at $1. Because these funds don't have federal deposit insurance to pay for, and needn't maintain a costly buffer of capital against potential losses, money fund users can usually feather their nests with higher income than traditional bank accounts can provide.

But it's precisely these characteristics that pose huge risks to the financial system. That's why it's so important to make the funds safer while protecting both taxpayers and the world financial system. Securities and Exchange Commission chief Mary Schapiro fought for changes that would do just that, but ultimately was defeated by industry lobbyists who opposed reforms.

Their opposition isn't surprising because the $2.6-trillion industry enjoys a heads-I-win, tails-you-lose business proposition. As things stand, money market funds can out-compete bank accounts by offering better returns to savers -- at least when interest rates aren't abnormally low -- while much of the risk is borne by taxpayers.

Consider what happened back in 2008, when the Reserve Primary Fund -- the nation's oldest money fund -- couldn't uphold the $1 per-share valuation investors take for granted. By breaking the buck, it set off an industrywide panic that was only halted when the Treasury guaranteed money fund accounts.

The government sustained no losses, but it might not be so lucky next time. And there may well be a next time because, while money funds aren't banks, they are vulnerable to runs. People who use money funds are notoriously risk-averse, and any sign of trouble gives them an incentive to flee, since those who delay may get back less than $1 per share.

Taken together, money market funds are simply too big to let fail, meaning that in a crisis Washington would have to step in with yet another guarantee. While the SEC has given up on new regulations, Schapiro could take the issue to the new Financial Stability Oversight Council created by the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act. But it's unclear if that panel has the power to act on its own.

What would worthwhile reform look like? Schapiro was backing three main changes, all worthy: requiring share valuations to float, as they do at other mutual funds, so investors see fluctuating prices as normal; mandating that money funds keep some capital on hand to cushion against losses; and making the funds hold back a small portion of investor withdrawals for 30 days. There's no denying these changes would lower returns for savers, who might flock back to traditional banking. But the risks of the status quo are unacceptable.

If meaningful new regulations can't be adopted, the Treasury and the Federal Reserve should announce that, after Dec. 31, they will provide no further bailouts for this shadow banking system. That will put savers and lobbyists alike on notice that this particular golden goose, fattened by taxpayers, will have to fend for itself. Maybe then the industry will find it worthwhile to quit ducking reform.