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$900 Billion in Capital Is About to Move

Six years after the financial crisis, the SEC finally concluded a four-year battle with financial industry lobbyists to toughen regulations governing money market funds.

Readers may remember that a run at the $62.5 billion Reserve Primary Fund during the 2008 financial crisis brought the multi-trillion money market industry to a standstill.

And it required federal intervention to prevent a market collapse…

The reason: the Reserve Primary Fund was forced to "break the buck" (that is, lower its price to below the $1.00-per-share industry standard for its type of money market funds) due to heavy exposure to plummeting Lehman Brothers debt securities.

Here's why the new regulations are about to cause a colossal market cash shift…

The Regulations That Will Change This Giant Market Permanently

The rules, approved by a tight (but unusually bi-partisan) 3-2 vote on July 23, require the riskiest funds, the so-called prime money funds to use floating prices for their shares. These funds cater to institutional and high-net-worth investors, and buy securities such as commercial paper issued by banks.

That is, instead of trading at a stable price of $1.00-per-share (meaning that $1.00 invested in a fund can always be redeemed for $1.00) prime funds will have to mark their shares to market based on fluctuations in the value of their underlying securities.

This is a radical break with industry norms that have employed fixed-rate pricing that ignored fluctuations in the prices of the underlying prices of their holdings.

As I mentioned, the Reserve Primary Fund was battered in 2008 by big holdings of Lehman Brothers commercial paper that was not being marked-to-market. If that situation were to occur today under the new rules, a fund would have to mark down its shares to below $1.00. For the most conservative investment imaginable, one often equated to a bank deposit in terms of safety, this would be a confidence-shattering event, just as it was in 2008.

The new rules also include measures to ease the tax reporting burden on fund investors. The U.S. Treasury Department and Internal Revenue Service agreed to require investors to account for gains and losses only once a year, at year-end, instead of tracking prices at which they buy or sell. The IRS also waived its "wash-sale" rule, which could have penalized investors who trade frequently in these funds.

In a nutshell, a massive "safe" money sector just got a lot less predictable…

This Shift Will Ripple Through Investment Markets

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About the Author

Prominent money manager. Has built  top-ranked credit and hedge funds, managed billions for institutional and high-net-worth clients. 29-year career.

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  1. Curtis Edmark | July 28, 2014

    More and "experts" are predicting that the bubble is about to burst.

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