New Rules May Make Money Market Funds Safer

New rules going into effect later this year are likely to work as designed -- shoring up money market funds. The regulations from the Securities and Exchange Commission require funds to have greater liquidity, higher asset quality and better disclosures. “The changes create a situation where there is a lower probability that there will be a run on money market funds,” says Jeffrey Elswick, a managing director at Frost Investment Advisors. “They clearly address some of the big risks in the business.”

But there’s a downside to greater safety. The same measures that make funds more reliable will hold interest rates down, making them less attractive to investors and leaving less money for business loans. Many companies and financial institutions rely on money market funds for short-term, low cost financing. “They are the oil that lubricates the economy,” says Peter Crane, head of Crane Data, about the importance of the funds in helping companies and banks access money. As more investors pull out of the funds, looking for better returns, more companies will have to turn to alternatives such as bonds to raise capital, and that will mean paying higher interest.

The new restrictions mean funds will have trouble reaching precrisis levels. In the past 12 months alone, as interest rates held steady at zero or close to it, total fund deposits fell 18 percent from a peak of $3.9 trillion to $3.2 trillion, according to an Investment Company Institute report.

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Expect assets to fall 10 percent more in the next 12 months. “It may be quite awhile before we get back to that peak level,” says Brian Reid, chief economist at ICI, a trade group. “Now that the restrictions have increased and money funds have become less competitive, their asset levels are more dependent on interest rates.”

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