Treasury Secretary Hank Paulson’s guarantee plan for Money Market Mutual Funds is not intended to guarantee that fund shareholders will receive what their shares are worth.  The intention is, rather, to guarantee that shareholders will receive more than their shares are worth, when their shares are worth less than $1 each (evaluated in the usual way by dividing the fund's asset portfolio value by the number of shares). The plan intends to inject taxpayer money so that no fund should have to “break the buck.” In the past, when buck-breaking seemed imminent, parent companies rather than taxpayers injected the necessary funds. Paulson wants to socialize the losses instead.

 

The Treasury seems to have overlooked that many of these types of funds are free of the risk of buck-breaking. These are funds that invest only in default-risk-free Treasury bills.  Many of the worried shareholders who recently cashed out of other MMMFs have moved to such T-bill-only vehicles. Paulson panicked because heavy withdrawals over a few days briefly reduced the ability of the riskier funds to buy commercial paper. A half-week’s problem has resulted in a temporary one-year guarantee program. But it is almost a cliché to observe that there is nothing as permanent as a temporary government program.

 

The $1-floor guarantee is attractive to shareholders who want the safety of a T-bill-only MMMF, but who are not willing to accept lower yields to obtain that safety. Why should taxpayers indulge a private preference for eating one's cake and having it too at someone else's expense?

 

The Treasury plans to charge covered mutual funds a yet unspecified fee. Why not let the market determine the proper price of safety by letting MMMF investors choose between T-bill-only and funds that invest in slightly riskier securities?  If the Treasury sets the guarantee fee too low (and they have no way of getting it right), then the guarantee system will foster moral hazard (a tendency to engage in riskier activity without concern that one would have to pay for those risks oneself).  Much like insured bank depositors, insured MMMF share investors will gravitate toward funds that carry riskier portfolios because the upside potential remains allocated to them while Uncle Sam covers the downside risk.