Money market investors balk at reforms For years, the leanest manufacturers have relied on "just in time" shipments of supplies from all around the globe, sometimes to the point that parts go straight from the loading dock to the assembly line. Companies no longer waste money funding expensive stockpiles, but they are vulnerable to supply chain disruptions like the Japanese tsunami in 2011. As the supply of parts dried up following the disaster, Japanese carmakers in the US slashed production and the Federal Reserve blamed the crisis for setting back the economic recovery. Corporations, government and investment firms have established the same kind of practices in finance, too, and one of the most important suppliers of just-in-time finance, the multi-trillion dollar money market fund industry, is urgently in need of reform. The bankruptcy of Lehman Brothers in 2008 was the earthquake that showed the modern financial supply chain is dangerously fragile. In the US alone, more than 60m retail investors, companies and other institutions have invested $2.6tn in money market funds (MMFs). This is a giant pool of money that gets lent out at short durations, in the commercial paper market where companies borrow to cover routine expenses like payrolls, to municipalities who borrow to cover seasonal shortfalls in tax revenues, and in the repo market where hedge funds and others finance big trading bets. MMFs" lending is a nice little earner, not least for investors who get more interest than they could at the bank, at what they are led to believe is no additional risk. Like banks, and unlike other mutual funds, MMFs promise to hand back exactly $1 for every $1 put in. No capital cushion or government guarantee stands behind the promise. When the Reserve Primary fund, the oldest MMF, found itself holding Lehman debt in 2008, it could no longer claim the value of its assets rounded up to $1. It would be 99 cents at best. It "broke the buck." Investors had lost money. The Reserve Primary news caused a run across MMFs, putting many more funds in peril and causing all that just-in-time finance to dry up. Only an emergency decree by the US federal government that it would prop up the industry was able to stop the run. Five years of water under the bridge and there are lots of temptations for keeping the status quo. Taxpayers were technically on the hook for trillions of dollars, but they never actually had to pay out - at least not that time. The US has since limited the risks that MMFs can take, so it is less likely one will be sitting on the next Lehman - but who can say where the next earthquake will be? Regulators in the US have been split on what to do. The Federal Reserve, which had to inject emergency liquidity into markets to replace MMFs in 2008, is adamant the risk of runs must be reduced. The Securities and Exchange Commission, whose concern is only that investors are not misled, is torn. The SEC has alighted on two imperfect ideas for reform: allow funds to stop people taking their money out during times of market stress; or stop funds from rounding their net asset value to $1, and instead force investors to cash in and out at the precise, floating value of the fund, to four decimal places. And here's the rub. Only about half the industry would be covered. Funds that target mainly retail investors would be exempt, on the grounds that it was more sophisticated institutional investors that started the run five years ago. It seems an odd underpinning for an SEC rule: hoping that retail investors are always "too dumb to run." Boston Fed president Eric Rosengren last week said the SEC's plans could be worse than the status quo. The threat that funds could erect barriers to exit might make runs more likely, since investors would have an incentive to pull their cash out while they still could. The European Union has gone further and plans to force MMFs to hold a capital cushion, the same way banks must. The industry says this will make many funds financially unviable. As for the SEC's plans, a BlackRock survey of institutional investors found almost half would stop using MMFs if they had a floating net asset value or exit barriers. Increasingly, it seems there is no adequate solution to systemic risk that does not also involve dramatically reducing the size of the MMF industry. Even the SEC's timid reforms could push up to $950bn of cash back into the traditional banking system, according to Georgetown University professor Jim Angel. The likelihood is this will further contract the commercial paper and repo markets, in turn discouraging just-in-time financing and leverage. For yield-starved investors, the end of money market funds as we know them would be a blow, but less of one while interest rates remain near historic lows and the differential between bank interest and MMF yields is small. It is a price worth paying to make the financial supply chain less fragile.