Money market funds are still an accident waiting to happen

US OUTLOOK

So farewell then Sheila Bair. America's most ferocious regulatorsays she will step down when her term as chairman of the FederalDeposit Insurance Corporation (FDIC) ends in July, robbinggovernment of one of the few people who still seemed keen on radicalreform of finance in the wake of the credit crisis.

As if she wanted to demonstrate why she will be so missed, MsBair was on typical bold form this week, attacking the powerfulmoney market fund industry and demanding sweeping changes. The $2.7trillion industry is based on a "myth", she said, and a dangerousmyth at that.

She is right. If the banks and fund managers ranged against hersucceed in killing real reform, it will be a scandal. Money marketfunds are hot money masquerading as safe money, and there is nothingso dangerous as something that looks safe and turns out not to be.The run on the money market funds in the days after Lehman Brotherscollapsed is the most under-appreciated aspect of the 2008 crisis.

While the bailout of AIG and the slumping stock market weregrabbing the headlines, the US authorities put a taxpayer guaranteebehind the whole money market fund industry, standing behind whatwas then over $3.4 trillion in assets.

It was the biggest and most repugnant bailout. But it wasessential. Without it, corporations would have been unable to paytheir employees and individuals would have started to see chequesbouncing.

This was the nightmare scenario that prompted action on CapitolHill - not any concern for the fat cats at Goldman Sachs, as thepopulists and revisionists would have it.

Money market funds only invest in very short-term assets -corporate debt that might get repaid in as little as a week or two -so there is supposedly little chance of losses. Fund managers workto keep their total assets stable at $1 per share. The idea that afund might "break the buck", as the saying goes, and fall below $1,is unthinkable. Millions of Americans, and millions more around theworld, therefore treat these funds as if they are risk-free higher-interest bank accounts.

Except they are not. If they were, Ms Bair's FDIC would regulatethem and guarantee them. In fact, savers are relying on nothingfirmer than the good investing sense of the fund's manager. And whenit turned out that the pioneer of the industry, Bruce Bent's ReservePrimary Fund, broke the buck because it was holding Lehman Brothers'worthless short-term debt, confidence evaporated and investorsheaded for the exits.

Without meaningful reform, an industry that was an accidentwaiting to happen before is an accident waiting to happen again.

An end to the "myth" of the fixed $1 net asset value and a moveto a floating NAV was proposed by Ms Bair this week (and supported,by the way, by the former Federal Reserve chairman Paul Volcker,another blunt speaker now outside the Obama administration).

Bank lobbyists countered that this would crater demand for theproduct, and in turn crater the amount of funding available to buyshort-term debt from corporations. But neither are bad things. Thefixed NAV is a marketing tool designed to dupe savers into thinkingsomething is risk-free when it is not.

And corporations shouldn't be hooked on short-term borrowing thatcould dry up at a moment's notice. It was exactly that addiction toovernight borrowing that made investment banks such as Lehman sofragile, and it is a terribly risky model for funding the salarycheques on which we all rely.

The taxpayer guarantee has lapsed now, but only really in thelegal sense. It still exists in investors' minds. And in bankers'minds, too, it turns out. They are lobbying for a Federal Reservebackstop as an alternative to the floating NAV. That would justentrench the industry as "too big to fail" and enshrine moral hazardinto law.

Ms Bair's legacy at the FDIC is an expanded regulator that nowhas oversight powers across all systemically important financialinstitutions and a new role winding up future Lehmans before theyget to the point of bankruptcy. But one of the biggest holes stillhas to be filled. Typically, Ms Bair has shown the way to fix it.

Google has its head in the clouds

Slowly but surely music is moving to the cloud. Following Amazonin March, Google this week started giving users access to a personal"digital locker" on its servers, for storing all your music files sothat you can listen to them over the internet on any device.

But Google's talks with the major record labels broke down inrather acrimonious fashion, so Google Music Beta has none of theextra services, such as a music store or file-sharing options, thatit hoped to launch.

The prevailing view is that the labels are being greedy, stubbornand stupid by not quickly agreeing licensing deals. Google andAmazon are offering new sources of revenue and, better still, thechance to entrench a new kind of paid-for music service that mightwean listeners off pirate downloads. One Google executive snippedthat the music firms were "less focused on the innovative vision weput forward, and more interested in an unreasonable set of businessterms".

Google needs to get over itself and its arrogant view that it isdoing the labels a favour. For the first time, digital music salesgrowth this year is more than offsetting declines in CD sales,according to Nielsen, so matters are not desperate. The labels - andtheir artists - deserve good terms, and Google must expect to pay upif it wants to offer a premium service to its users.