Capital Ideas Blog

what would mary poppins say about the sec

By Hal Weitzman

From: Blog

If you want to understand what causes financial crises, re-watch Mary Poppins (and if you've never watched this 1964 Disney classic, shame on you).

Then consider the famous scene in which old Mr. Dawes, the venerable patriarch of Dawes, Tomes, Mousely, Grubbs, Fidelity Fiduciary Bank, wrestles with Michael Banks over tuppence. Dawes Sr. wants Michael to invest it in the bank, while the young boy wants to buy a bag of birdseed so as to "feed the birds." The tussle prompts a bank run, the institution's first since 1773.

So begin all financial crises (for more examples, see here). Runs aren't only on banks: In 2008, spooked investors pulled money out of the Reserve Primary Fund in the US over worries about its exposure to Lehman Brothers. The result was that the fund "broke the buck," and its net asset value fell below $1 per share.

On Wednesday, the Securities and Exchange Commission adopted a rule designed to prevent runs on institutional money market funds, requiring their value to float instead of maintaining a value of $1 per share. The "floating NAV" (net asset value) is supposed to prevent investors from worrying about the prospect of funds breaking the buck.

All solved? Not so fast. The Squam Lake Group, comprising 12 of the world's top economists (three from Chicago Booth, two from Harvard, two from Dartmouth, and colleagues from Stanford, Columbia, Yale, Ohio State, and the Brookings Institution) noted in a letter to the SEC last year that the reforms would not necessarily prevent runs.

Floating NAVs don't reflect fair market values of money-market funds, they write, since the funds can amortize their costs over 60 days. If investors can redeem at a NAV higher than the fair market value, they have an incentive to run. Moreover, since money-market funds are built on short-term debt used to make longer-term investments—assets that lack a liquid secondary market—investors have an incentive to run during a panic, since even "fair market value" may be well above the value at which the fund can quickly sell assets to meet investor redemptions.

The SEC's new rule may appear to be a "spoonful of sugar," but it mightn't contain the medicine needed to ensure financial stability.


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