Prospects, challenges of the money market funds
In the 1950s inflation was something that happened to a beach ball. Bonds were a conservative investment, and a ''mutual fund,'' to most people, meant a company that invested in stocks.
Since then the economy has changed, and so has the mutual fund industry. Money market funds have become the financial success story of the '80s. Traditional equity funds have become more specialized, with new products popularized over the past several years, including discount bond funds, long and short-term municipal bond funds, option income funds, and international diversified funds.
''In a sense the industry now has a built-in stabilizer,'' says David Silver, president of the Investment Company Institute. ''One part of the range of products should appeal to investors no matter what the economic climate happens to be at any particular time.''
Mr. Silver is the mutual fund industry's man in Washington. During an interview in his K Street office, he discussed some of the issues which will affect mutual funds in the near future: Money market funds and falling interest rates
Money market funds have accounted for 84 percent of the mutual fund industry's growth since 1973. Their assets have climbed steadily upward, reaching $172.7 billion last week. As interest rates in the short-term money market fall, money fund yields follow downward somewhat more slowly. What will happen to the funds?
''If interest rates continue to decline, and go down to, say 8 percent and stay there, we will probably lose some money from the funds. This has happened before,'' says Mr. Silver. ''But so long as the yield stays reasonably competitive, the services funds provide will assure they remain healthy and vigorous. At any rate level, except down at the passbook rate, you can't match the liquidity of a fund. Also, money in MMFs which are part of a complex of funds can be switched with amazing ease and convenience into another type - a stock fund, a bond fund.
''There's another aspect to it. Probably 5 to 7 million people never had anything to do with mutual funds before and have bought MMFs as their first mutual fund investment. You do something the first time, it becomes easier to do later.'' Money market funds vs. All-Savers certificates
The All-Savers certificate, in Mr. Silver's words, is ''the most heavily promoted financial product ever,'' as well as ''the most extraordinary boondoggle of the century.'' Designed to divert some of the cash flowing into money funds into banks and thrift institutions, All-Savers attracted an estimated $40 billion during October. But MMFs kept growing, ringing up another
''The banking industry expected that by the end of October money market funds would drop dead. It obviously hasn't happened. There has been very little change in the growth patterns of MMFs,'' says Silver.
Alfred Johnson, Investment Company Institute chief economist, says some of the All-Savers money must have flowed out of money market funds. But he estimates passbook savings accounts for 15 to 20 percent of the ASC inflow, with most of the remaining money coming from 6-month certificates of deposit and other small time deposits.
''Everybody is running around with lanterns, going 'Where is the money coming from?' '' says Mr. Silver. ''There's a lesson in all of this somewhere. The one thing you can be sure of is Congress won't see it.'' Should banks be allowed to sell securities?
Legislation now before Congress would permit banks, with certain conditions, to sell securities - an action illegal for over 100 years, except for a short period in the 1920s.
The Investment Company Institute thinks such a move would be anti-competitive and dangerous for investors.
''Everybody's afraid to say the emperor has no clothes,'' says Mr. Silver.
He cites two reasons for his opinion:
1. Banks would quickly gobble up most of the business. ''It's not generally realized that by 1930 (three years after the McFadden Act legalized bank underwriting of corporate securities), banks had captured over 60 percent of the market for the underwriting of corporate debt issues,'' points out Mr. Silver.
In 1933 Congress took a look at what the McFadden Act had wrought and reversed it with the Glass-Steagall Act. If Congress reversed its position yet again, Mr. Silver says, the same result will occur.
''It is vital for firms to have a sound relationship with their commercial banks.'' he continued. '' This gives the banks a unique advantage over every type of financial service company when it comes to marketing securities. People will lead themselves to believe that they can get some edge (toward getting a loan) by using a bank's other financial services.''
2. Investors would have less protection. ''The Glass-Steagall Act was enacted to cure a host of problems that had nothing to do with competition but had everything to do with protecting the public,'' says Silver. ''Securities law would be ineffective because it doesn't refer to banks. Remember, every abuse of the '20s was replayed by the Real Estate Investment Trusts in the '60s. Change over the long run may be inevitable, but if it's made without addressing some question of investor protection there is the potential for economic disaster.''