ABA: Money Market Bailout Could Compromise Bank Deposits

Citing “deep concerns” about the Treasury’s program to guarantee money market mutual funds, American Bankers Association president Edward Yingling said that the bailout of money markets “will undermine the role of banks during this current crisis and has the potential to have an extremely negative impact in the future.”

The U.S. Treasury moved Friday morning to insure money market funds, after a few funds “broke the buck” earlier this week; the government plans to use as much as $50 billion from the country’s Exchange Stabilization Fund to protect investors from losses, while the Federal Reserve said it would extend non-recourse loans to banks for purchasing asset-backed commercial paper. See full coverage.

In a letter to Treasury Secretary Henry Paulson and Federal Reserve Chairman Benjamin Bernanke, Yingling posed eight questions about the money market program, the most pointed of which asks “how will you address the perception by the market that money market mutual funds now have a permanent implicit government guaranty – much like Fannie Mae and Freddie Mac did?”

Yingling said in his letter that a great majority of banks never made a subprime loan and have paid billions of dollars into the FDIC fund for the past 75 years. And while the nation’s financial system is under stress, he stressed that 98 percent of banks are well-capitalized and reporting profits and continue to make loans in their local communities.

“The debt instruments in a money market fund will pay a higher interest rate, and therefore, the fund will pay a higher interest rate than a bank deposit or short-term CD,” said Yingling. “It also appears that there will be no limit on how much an individual or institution can invest in these funds. Therefore, they will be in a significantly superior market position to FDIC-insured bank deposits.”

In plain English, this means that the ability of banks to attract and keep deposits may come under pressure as a result of the move to bail out money-markets — and if there ever were a time where the last thing banks want to see is deposits walk out the front door, this would be such a time.

Some of HW’s sources suggested that depending on how the program is structured, it’s possible that the Fed’s move to prop up ailing money markets may come back to push further banks into FDIC hands via a weakening deposit environment.

“That sound you hear is the FDIC upping its troubled institutions list,” said one senior banking executive, who asked not to be named in this story.

Read the full letter here.