Confrontation looms over defence of the money funds

When top officials of the US mutual fund industry gather here for their annual convention May 13 to 15, one issue is likely to dominate many of their conversations:

How to protect the asset-rich money market funds from the Federal Reserve Board's anti-inflation credit curbs, as well as from stepped-up efforts of the banking industry to hobble the mutual funds with new laws in state legislatures.

The concern about the future growth of money markets is already prompting the industry to weigh the possibility of legal action to overturn the Fed's credit curbs. These restrictions, announced March 14 as part of the Carter administration's anti-inflation policies, required money market funds to set aside a 15 percent reserve on any increase in assets after March 14.

At the same time, the industry is being forced to step up its political action in a number of state legislatures to prevent state agencies from listing money funds as "banks," a step that could impose a number of stiff curbs on their ability to grow at the local level.

The innovative money funds have already come up with a number of alternatives for side-stepping the Fed curbs:

According to an official of the US Securities and Exchange Commission, several funds appear to be moving to change the structure of their money market funds so they have three classes of fund holders. The restructuring would come through a vote of shareholders.

The first class would encompass all who were fund holders before March 14, whose deposits made before that date would not be legally affected by the 15 percent set-aside.

The second class of fund holders would be all "persons" or "groups" exempt from the set-aside restriction, such as financial institutions or pension plans.

The third class would represent post- March 14 shareholders subject to the set- aside.

This three-tiered system is expected by many legal analysts here to be the direction money funds will go, rather than the "clone" funds that have been already set up by a number of established funds. (A clone fund resembles the regular fund, except that it is used for new shareholders, and is subject to the set- aside.)

Although the Fed eventually backed down somewhat by exempting smaller funds with assets of $100 million or less from its March 14 rules, the overall set-aside curbs have not yet put the brakes on the pellmell growth of the money funds.

According to figures provided by the Investment Company Institute (ICI), main trade arm of the mutual fund industry, assets of money funds reached $61.3 billion on March 19, shortly after the Fed's announcement.

By the week of April 16, assets had dropped to $60 billion. By April 23, however, assets were back up to $60.4 billion.

By May 3 they were up to $60.7 billion.

Currently, money fund assets are around $63 billion -- higher than at the time of the March 14 set-aside announcement.

Significantly, most of that "new" money has been invested in the older, "regular" funds. Only about $750 million belongs to some 27 new "clone" funds set up solely for new, post March 14, investment dollars. Still, the ICI will consider further legal action if the Fed does not rescind the set-aside regulations, says David Silver, president of the ICI.

According to Matthew Fink, chief legal counsel for the ICI, the set-aside regulations inhibit people of relatively modest means from offsetting inflation through their savings. Further, they reduce the amount of money available for productive investment in the US economy. There is also a legal question, Mr. Fink argues, about whether the set-aside provisions can be applied to the mutual fund industry under terms of the Credit Control Act of 1969 -- the statute used by the Fed (and the Carter administration) to justify the credit curbs.

Perhaps bolstering the legal position of the mutual fund industry is the fact that in January of this year a Senate banking subcommittee brought in top US bank and securities regulatory officials to discuss money market fund legislation. Significantly, none of the top officials saw a need for a reserve requirement on money funds.

In fact, Treasury Secretary G. William Miller, in subsequent testimony, also came down squarely against reserves.

To date, the ICI has not received any word from the Federal Reserve board about its petition to rescind the set-aside.

In addition to the set-aside provision, the industry is also being forced to redouble its efforts in state legislatures to prevent banking lobbies from having money funds declared to be "banks," and subject to restrictive bank regulations, including reserve requirements.

The industry recently was successful in squelching such a banking industry effort in Tennessee.

In Louisiana, however, banking interests have been successful in getting Merrill Lynch & Co.'s Ready Assets Trust declared a bank. The industry is currently challenging that order and a decision from state officials is expected shortly.

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