There is a high potential for another blow up in the market place and this time it could be good for banks. Yesterday, FOMC Chair Ben Bernanke predicted that there will be more regulation for the money market mutual fund industry in the near future. This industry is having some deep problems and may soon cease operations in its current form. After several funds "broke the buck" back in Sept. due to Lehman Brothers losses and redemptions, this $3T market continues to take a beating.
One problem is low rates. With yields for average funds hovering in the 20bp range, most fund companies have waived fees to keep returns to investors from going negative. As a result, several funds have decided to get out of the business entirely. Other funds have decided to waive all fees and even subsidize operations. This can't go on forever and given the view of rates, we expect many more money market funds to close up shop within the year.
Next to rate, the other major risk is credit. Currently, many funds are operating under a $50B government guarantee that is set to expire next month. While we expect this guarantee to be extended until September, there is most likely a political limit to how far Congress will go. Once the guarantee goes away, the industry is just one more credit event from disaster. As the president of JP Morgan's Asset Management unit said a couple of months ago, money market funds pose the "greatest systemic risk that hasn't yet been adequately addressed."
One issue that will most likely be made clear to the press and the public is that the money market fund industry is only lightly regulated. Unlike banks, there are also no capital requirements or any other credit/liquidity support structure. These factors are one of the main reasons why funds are able to offer better rates than banks and why the money market mutual fund industry is the largest single factor in why bank's deposit costs have been driven up over the past two decades.
Look for dramatic changes to the money market fund industry soon. At a minimum, they will have more investment restrictions placed on them limiting investments as to credit, liquidity and duration. In addition, a very real possibility is the fact that money market funds, like longer term funds, will have a variable net asset value and thus be more likely to have fluctuating price. Finally, regulators may now require fund companies to hold capital as reserve for potential losses. In either case, these changes could result in a shift in economics for money market mutual funds and large inflows could occur to banks.
For banks looking to pick up deposits from this market situation, you should start a dedicated effort now. Training on how money market mutual funds work, what they invest in and understanding rates of return will all make frontline staff more informed and confident when talking to the public. Most fund investors don't have a good understanding of the credit and liquidity risk they are taking. For example, few investors remember that the fund's early cut off times hurt their liquidity often preventing same day access to funds. We would love to see a bank go so far as to publish a pamphlet on the differences in order to aid in consistent understanding (we could be talked into producing if banks wanted to split the cost?).
Our point here is that banks should start to execute a strategy based on products, training and marketing that is specific to money market mutual fund holders. Banks can now offer better rates, more flexibility and much better safety. While this market turmoil is hurting banks, it also presents some significant opportunities to lower cost of funds.