Money market account redemption hysteria

A friend recently emailed me some links that warn of impending financial disaster. He noted that I don't often write about economics, which is true.

So I took a look at a couple of the sky is falling posts and will report on my impression of them. Which is, in a word, yawn. I don't feel a pressing need to invest in an umbrella to protect against sky pieces.

My first stop was "Is the US Goverment Preparing the Lifeboats for the Next Financial Disaster?" I guess this title is supposed to be critical of the (misspelled) government. But isn't it better to have a lifeboat than to go down with the ship?

The post references a longer analysis of supposed proposed rule changes by the SEC and the Obama administration.

The primary concern seems to be the new ability of money market fund managers to freeze redemptions (withdrawals) of funds at their discretion.

"A key proposal in the overhaul of money market regulation suggests that money market fund managers will have the option to 'suspend redemptions to allow for the orderly liquidation of fund assets.'"

Well, it's hard for me to get freaked out over an effort that would stem panicky bank runs. This sounds like a good thing, not a bad one.

Maybe the author of this post doesn't realize that banks don't have a big vault where everybody's deposits are kept in cash. Money comes in to a bank, and then it is loaned out -- or otherwise invested.

So only a certain amount of cash is available at a given time. If every depositor lined up outside the bank and demanded his or her money in green stuff, it'd be impossible to immediately satisfy them.

Modern money market funds appear to be even less cash'y. I'm vague on how the inflows and outflows work, but the "bank run" principle seems to be the same: if every owner of a fund wanted all of their money cashed out pronto, it would be very difficult, if not impossible, to accommodate the requests.

Government regulations help protect investors against excesses. Excessive risk-taking. Excessive greed. Excessive duplicity. And also excessive panic.

The New York Stock Exchange has "circuit breakers" that halt trading for a while when the Dow Jones Industrial Average is sinking like a stone.

In response to the market breaks in October 1987 and October 1989 the New York Stock Exchange instituted circuit breakers to reduce volatility and promote investor confidence. By implementing a pause in trading, investors are given time to assimilate incoming information and the ability to make informed choices during periods of high market volatility.

Most stock trades are done by professionals. Yet it's realized that even investing pros need to take a deep breath at times and not follow a panicky sell, sell, sell herd mentality.

The general public is even more prone to making the wrong investment decisions at the wrong time. Lots of studies show that people tend to buy at market peaks and sell at market lows.

That's why I've become a big fan of index investing, as noted in this post. I wrote it in early March of last year, when our portfolio was down about 30%, compared to the broader stock market decline of 40-50% since the big downturn began.

I just checked our Mint (a great financial web site) chart. We're now down less than 5%. If we'd cashed out of the markets when things looked absolutely horrible, our losses would have been locked in.

Sometimes people have to be protected from themselves. I've been investing for over thirty years and have come to understand the dangers of me believing that I can time the markets. Many (or most) people haven't come to this realization.

I'm a libertarian on quite a few social issues, but not when it comes to regulation of the financial markets. So regulate away on money market accounts, SEC and the Obama Administration.

Comments

[Rain]

It's the media that does this. We had money in a Wells Fargo account of some sort last spring and wanted to move it. It wouldn't let you do it right away even then. It's the media or some analyst who has to find something to write that stirs this all up. They would love a crash for that reason.

[Blogger Brian]

Rain, I tend to agree that many people -- such as Obama haters and sensationalist media outlets -- play up a crisis mentality for their own ends.

I just came across this description of the banking system in TIME magazine's Man of the Year issue (the fed chairman, Bernanke, won the honor). It shows why people can't always expect to get their money out of a bank instantly.
---------------
"How the Banking System Creates Wealth

(1) A saver deposits $100 in a bank; a federal guarantee ensures that he can withdraw it later.

(2) The bank holds $10 in reserve and lends the other $90 to a borrower, collecting interest on the loan.

(3) The borrower's $90 is spent and gets deposited in another bank, which then lends out $81 of it.

(4) Eventually, the original $100 deposit expands to $1,000 with $100 now held in reserve.

In this system of fractional-reserve banking, too many withdrawals at once could cause a crisis. The Fed was created to minimize that risk.

[tucson]

In commodity futures contracts there are trading limits set. Once that price level, above or below the previous days closing price is reached, trading is suspended for the day or until an offer is made in the opposite direction the market has moved to its set limit.

This type of mechanism, as Blogger B. pointed out, helps prevent wholesale panic and destruction of orderly markets and the banking system. It's a good thing. Sometimes people go crazy for no good reason based on rumor, fear and emotion.

These sorts of mechanisms, however, do not guarantee against chaos in banking and financial markets. It is possible to conceal certain conditions that, if revealed, would result in a panic regardless of market rules.

I believe that the current fiat currency policies by the Federal Reserve Bank are just this kind of deception, like putting your finger in a dike that is about to burst and saying everything is OK. You can't create (print) wealth out of nothing forever creating inflation to stave off a depression and the ultimate price of financial irresponsibility and credit excess...bankruptcy. Technically, the U.S. is broke but it has a few assets that give some hope but not much optimism.

I don't know what is going to happen or when, and I am not yet fully investred in the three B's (beans, bullets and bullion). But I would have some sort of contingency plan should this very shakey system fail.

Keep your debt as low as possible and pay it down as fast as possible. Live within your means and if you can't pay cash for something wait until you can unless it is an emergency.

This is what our government needs to do right now even if it means a prolonged recession or even depression. The time has come to pay the piper for decades of excess or ultimately the system will break. In fact, some think that would be a good thing in order for the phoenix of a new, theoretically better system to rise from the ashes. I don't.

Own real property and not just financial instruments, securities and derivitives which can and do go up in the smoke. Own some stuff people always need like food, clothing, shelter, tools and medicine. Keep your house in order. Maybe 5-10% of your portfolio could be in gold and silver which hold some value in a currency crisis and as an inflation hedge.

Bear in mind that if times get really tough even these commodities aren't worth much. You can't eat bullion nor can anyone else.

Then you're down to two B's...beans and bullets. Let's hope we get come competent people in government soon so that doesn't happen. In may not be too late.

[Blogger Brian]

tucson, I agree with you about gold/silver (and also on some other points you make -- we are indeed living beyond our means). I can't bring myself to invest in gold, because it seems to be as abstract as paper money. I mean, gold, like a dollar bill, is only worth what other people believe it is. There's little intrinsic value to it, aside from its jewelry and industrial uses.

Like you said, "investing" in real things makes more sense to me. Making one's home as self-sustainable as possible, for example. Putting in some solar panels. Storing up food, seeds, fertilizer, whatever. Insulating to reduce energy costs. Using money in these sorts of ways produces real benefits to one's real life, whereas nobody can eat, wear, or live in gold.

[Rain]

That's what we have thought-- have trade goods on hand. Most gold isn't really owned by anyone but it's a paper certificate that says it's there. If it was in your home, it'd be wise to be in coins or something small enough to actually trade... assuming people really wanted something like that instead of tools or food

[tucson]

Blogger Brian. Everything you said about gold is true, but also true of any "symbolic" asset people hold such as stocks, bonds, paper money, etc.

It is a hedge against inflation and will almost surely have more value than a failed currency, stock or bond. It is not unreasonable to have some actual physical gold for a rainy day.

Silver can serve the same purpose as gold and it has more industrial uses but it is bulky. At current rates it takes about 62 pounds of silver to equal one pound of gold.

Gems can be a compact means of wealth preservation in the event of inflation or chaos but you have to be very sophisticated in that field or you will probably be taken to the cleaners. It's not for amateurs.

[Randy]

I'll keep trying to argue that:
You really can't depend on gov., that the Fed wasn't created to minimize the risk caused by fractional reserve banking, etc.

http://kunstler.com/blog/2010/01/the-futility-economy.html#more

[John Elsen]

I'm surprised that many don't see an issue here. Access to "safe" funds like MMFs is what creates liquidity and allows normal commerce. These rules will cause deposits to move elsewhere, and this could have negative effects throughout the system. When is it going to be clear that fractional reserve banking only makes sense when the required reserves are at meaningful levels?

[tony]

It is time for people to start thinking a little deeper. Life isn't that simple, and finance is one of the most complex subjects. Simple minded, and SHORTSIGHTED policies like this will be disastrous. Giving up control of your money is ridiculous.

When you NEED your money, how do you get it? Or are you so dimwitted you think you won't actually need it during a financial crisis. Or did you think that 2008 was the last one ever?

Just take a look at what kind of hell has befallen people who were locked out of their money for over a year when they froze Stanford accounts (seriously, google it) There are plenty of normal, every day people, suddenly cut off from access and now need their money and can't do a damned thing about it. Imagine if that was you. Read stories about what they are going through. What is there to praise about this idiocy? Money markets are SUPPOSED to be liquid accounts and serve a very crucial purpose. If they are not liquid, then you might as well get the cash in your hand.

Fools. You willing bow down and give power over your very life to some bureaucrat never met. THINK sheeple.

[Blogger Brian]

tony, here's some basic financial facts: if you want guaranteed instant access to your money, keep it in cash.

Banks and money market funds don't keep everybody's money in vaults with the cash tied up with a big red bow around it. Modern economies don't work that way.

Financial institutions are only required to keep a certain amount of cash on hand for depositors. I think it is 5% of deposits, but could be wrong. So runs on a bank can wipe that out. It isn't reasonable to guarantee every depositor instant access to all of their money.

This isn't foolish. It is good economics.