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nZ\(\1)lr 0J(6\ 11'\\1f rr CC; n8)CC(G) 0 March 20, 1981 - - - - -------- The Fundsandtheir Critics Widows and orphans, to their great delight, have suddenly found a way of tripling what they could earn on their passbook savings, simply by shifting their funds into moneymarket mutual funds (MMF's). Bankers and thrift-industry executives, to their great chagrin, find itdifficultto match this competition because of the legacy of legislation passed almost a half-century ago. And Senate Finance Committee Chairman Jake Garn, calling the funds "legal but unfair," has announced that he'll call hearings soon to do something about the situation. Money funds pool the money of many investors and place it in various liquid investments, such as Treasury bills, commercial paper, and bank certificates of deposit. Without pooling, those investments would be out of the reach of most small investors.. But through a money fund, a small saver can earn interest at rates much higher than the maximum 51/4percent that commercial banks can pay on traditional savings deposits-indeed, more than three times higher at recent M M F rates. And many funds also permit investors to write checks on their funds, although generally in minimum amounts of $250 to $500. Stratosphericgrowth With such advantages, money-market funds have grown stratospherically in the last two years, and especially in the last several months. A few mutual-fund firms began to offer money-markeffunds about a decade ago, when they saw that moneymarket instruments offered much higher yields than equities in a growing environment of inflation and high interest rates. Still, M M F assets barely exceeded $10 billion as late as December 1978, at which point they began to soar as the investing public re,. sponded to the growing differential between their yields and passbook-savings rates. Last week the assetsof the 1OO-odd money funds reached $101 billion, for a 35-percent gain just since the beginning of this year. Depository institutions ar€ dismayed by this trend, especially in view oftheir difficulty competing directly with the funds. But their consumer deposits still dwarf money-fund assets in size (see chart). In January, banks and thrift institutions held about $377 billion in savings deposits, not to mention $778 billion in time deposits under $100,000. Restrictive legislation The present situation can be traced to the restrictive legislation of the 1930's, which developed the concepts of deposit interestrate ceilings and the separation of investment banking from commercial banking. Congress passed the Banking Acts of 1933 and 1935, the Glass-Steagall Act of 1933, and the Securities and Exchange Act of 1934 to "establish a sound financial system." But in practice they tended to limit competition, especially bank competition, and involved increased Federal regulation of financial and banking markets. Later, as financial institutions innovated to avoid these restrictions, Congress acted to plug the loopholes-for example, by extending interest-rate ceilings to thrift institutions in 1966. Many of these.restrictions became untenable in the 1970's, however, because of high and Variable interest rates, credit crunches due to deposit interest-rate ceilings, and technological changes such as computerized cash-management techniques. Banks made more intensive use of funds not subject to interest-rate ceilings, such as repurchase agreements and Eurodollar deposits. Regulators allowed institutions to offer new instruments at rates more closely tied to market rates, such as money-market certificates. Thrift institutions created new interest-paying check-like accounts, such as share drafts and N OW accounts. And money-market funds came into being as liquid, higher-yielding alternatives to bank checking and savings accounts. Congress legitimized many of these innovations by 11 § IFi f @.LmCCII (C Opinions expressed in this newsletter do not necessarily reflect the views of the management of the Federal Reserve Bank of San Francisco, nor of the Board of Governc)rs of the Federal Reserve System. quirements that funds invest a specific portion of their assetsin states where they have account holders. The Massachusetts bill, for example, would have required a Community Reinvestment Act-type of disclosure of M M F local investments. passing a landmark piece of legislation last year, which (among other things) called for the removal of all deposit interest-rate ceilings over a six-year period. The legislative changes of the past generation did not create a "level playing field," however. The SEC,the watchdog of the investment-banking industry, applies one set of rules to mutual funds and other investment firms; various depository-institution regulators apply separate sets of rules to commercial banking and thrift-institution activities. Money-fund assetsare not classified as deposits, despite their similarity to bank deposits, according to a recent Justice Department ruling. Thus the funds don't have to put aside a portion of their assetsin sterile reserves, as banks and thriftsha\;e't6--do with their deposits. However, during last spring's brief credit-control program, the funds became subject to a 15-percent reserve requirement on increases in their assets. The Illinois legislature is considering a bill that would authorize banks to offer moneymarket funds, although this could conflict with Glass.:.Steagallprovisions separating commercial from investment banking. In this connection, the Supreme Court ru led in 1971 against a commercial bank which had set up a commingled mutual fund of the type now being considered, although that approach would have involved investment in equities, ments. In addition, the Washington legislature is considering a bill that would permit state-chartered financial institutions to set up special money-market time accounts supported by equal amounts of segregated assets. Under this plan, each account holder would be paid interest at a rate based on the yields of the particular investments supporting the account. Again, because of the difference in legislative history, the funds have always been able to offer market interest rates, whereas banks and thrifts are still limited in their deposit activities -with restrictions either on their interest rates, maturities, or deposit size. And while several mutual-fund companies now own banks, banks are not permitted to own mutual-fund companies, sell securities, and underwrite municipal revenue bonds. In another approach, the Utah legislature considered (and narrowly defeated) a bi II calling for state regulation of funds offering check-like services. This would have required the licensing of funds lito help assure that checks will be paid upon presentation," and would have required that checks drawn upon fund accounts be "two party," that is, payable only to the investor himself. In other words, this legislation would have prohibited the third-party payments which are characteristic of transaction accounts in depository institutions. Separately, an Oklahoma legislator introduced legislation that would require money funds to advertise that their assetsare not insured, as deposits are. legislative pressures Against that background, the critics of the money-market funds have'generated a flurry of activity in the halls of Congress and many state capitals. Iowa Congressman James Leach recently submitted a bill that would authorize the Federal Reserve to impose reserve requirements on M M F transaction (check-like) accounts. State legislatures in Alaska, Washington, Utah, Massachusetts, Georgia and Oklahoma meanwhile are discussing legislation that would restrict M M F activities in various ways-for example, by credit-allocation re- Funds'defense The mutual-fund industry is now fighting back, in the press and in the halls of Congress and the various state legislatures. (In fact, some funds are encouraging their customers to write their Congressmen, recog2 $ Billions 400 -----. - --------_. 800 . t-Time Deposits Under $100,000 Savings Deposits-( Depository Institutions .. Do I 200 100 50 1977 1981 lations, the funds would channel more funds back into smaller communities. nizing that more than five million satisfied customers could represent a potent lobbying force.) The funds argue, in effect, that they are not competing unfairly, and that depository institutions could obtain ample funds if they offered the large time certificates that the funds buy. Regulatoryresponse? In light of such conflicting claims about the M M F phenomenon, what can hard-pressed legislators and regulators do? One approach would be to reverse the deregulation trend, primarily by imposing reserve requirements on the funds similar to those imposed on their competitors. This raises the question of whether M M F shares are held as savings or as transaction balances. In the former case-individual shares-the relevant reserve requirement would be small or even zero. But in the latter case-institutional accounts-the requirement would be somewhat larger. Regarding checking-account privileges-a sore point with the competition-the funds argue that the privilege is rarely used. Most funds stipulate a minimum of $500 per check, and the average holder draws no more than two or three checks a year. Regarding their lack of insured status, the funds claim thatthey are indeed quite safe, and that no one has ever lost a penny in them. The average maturity of the investments is now around 30 days, and some average a week or less, so that the funds are largely protected against capital losses when interest rates rise. A second approach wou Id be to speed up the deregulation trend and widen the opportunities for banks and thrifts to compete with money-market funds. The Depository Institutions Deregulation Committee, set up to implement last year's financial legislation, has some flexibility in this regard-but the committee has already been attacked by some thrift-industry spokesmen for moving too fast in deregulating deposit interest rates. Another possibility would be to permit depository institutions to set up their own money-market funds, through a revision of Glass-Steagall restrictions on such activities. (A bi II of that type got through the Senate as far back as 1969.) Banker groups are now proposing a bill that would amend Glass-Steagall to permit banks, bank holding companies, and S & L's to create or operate investment companies, such as money-market or equity funds. Fund executives also deny that they are harming depository institutions by their growth. They note that most of the money in the funds is in relatively large accounts, with nearly half of all M M F shares held by institutions. The average fund-holding is about $1 5,000, and the vast bulk offund shares is in accounts of $1 0,000 or more. Thus, money of this type can easily move into Treasury bills or other instruments requiring miminum investments of $1 0,000 or moreand would not tend to stay anyway with banks or thrifts. While agreeing that some fund shares may be bought with funds withdrawn from depository institutions, money-fund spokesmen also note that almost one-half of their assets are invested in depository-institution debt obligations, such as large time certificates and bankers acceptances. Smaller banks and thrifts claim that the funds siphon off their deposits into large money-center banks, but the M M F's claim in rebuttal that they are simply operating in conformance with SEC regulations. Some observers claim that with a liberalization of those regu- With such changes, banks and thrifts could carve out a niche for themselves in a fastgrowing field. Otherwise, the money funds would have a clear field for further growth in today's environment of inflation and high interest rates-especially as the current debate continues and more widows and orphans learn of their advantages. Verle Johnstonand William Burke 3 !!PMl'?H • • lIl'?ln • P!UJoJ!Il'?:) • CG) • l'?Pl'?i\aI'J • 04l'?PI l'?UOZ!JV• E'>jSE'IV Jr CD) JJ, BANKIN G DATA-TWELFTH FEDERALRESERVE DISTRICT (Dollaramountsin millions) SelectedAssetsand Liabilities large Commercial8anks Loans(gross,adjusted)'andinvestments* Loans(gross,adjusted)- total# Commercialand industrial Realestate Loansto individuals Securitiesloans U.s.Treasurysecurities* Othersecurities* Demanddeposits- total# Demanddeposits- adjusted Savingsdeposits- total Timedeposits- total# Individuals,part.& corp. (LargenegotiableCD's) WeeklyAverages of Daily figures Member8ank ReservePosition ExcessReserves (+)/Deficiency(-) Borrowings Net freereserves(+ )/Netborrowed(-) Amount Outstanding 3/4/81 146,888 124,512 36,794 51,236 23,528 1,389 6,690 15,686 42,616 29,324 29,892 76,571 67,415 29,449 Weekended 3/4/81 n.a. 35 n.a. Change Changefrom yearago from Dollar Percent 2/25/81 8,503 443 6.1 437 8,241 7.1 2,580 7.5 170 6,389 14.2 92 40 963 3.9 259 152 22.9 15 0.2 1 277 5 1.8 2,041 - 4.6 3,454 - 2,188 - 6.9 1,651 2,015 7.2 665 767 16,725 27.9 475 16,218 31.7 8,120 387 38.1 Comparable Weekended 2/25/81 year-agoperiod n.a. 87 n.a. - 66 250 184 * Excludestradingaccountsecurities. # Includesitemsnot shownseparately. Editorialcommentsmaybeaddressed to the editor (William8urlce)or to the author.... Freecopiesof this andother federal Reserve publicationscanbeobtainedbycallingor writing thePublicInfonnationSection, federal Reserve8ankof Sanfrancisco,P.O.80x 7702, Sanfrancisco94120. Phone(415) 544-2184. 21 I C@I
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