As posited, they’re almost golden, so why doesn’t there exist a split-the-difference insurance regimen that guarantees positive return for everyone involved, in spite of [posited] short-term, short-sighted marking requirements?

I began in the financial/investment business in 76 (I’m retired now)
and don’t disagree with you. My major worry, which federal “insurance” DOES ameliorate, is the panic that comes from lawyers and accountants, with Enron on their minds, jawboning their companies into writing down good assets (94%+ of all mortgages are currently performing) to crazely insane levels by 80-90% write-offs, all to march to the tune of the FASB which idiotically imposed “mark to the market” rules on long-term instruments designed to be held only by institutions (as one old bond trader told me when I first came into the business: “Only Institutions can truly afford to hold bonds long-term”.) Granted that these CMO’s were complicated and “opaque” financial vehicles to say the least, and the risk involved poorly understood—and those flogging them less than introspectively concerned about their “fit” for any and all investment profiles—but even so, if held to maturity almost none of them (the bundled CMO’s) would have been under the water—and if not required to be marked to market could have been used to settle interim trades based on a NAV of close to par or counted as par for accounting purposes when calculating the book value of the financial firms holding them in their portfolios—all without the sturm und drag that brought the system down.

Thus, by my lights, the current Federal “assurance” should have never been needed in the first place were it not for an Enron-leary FASB. Enron was also the reason the ratings agencies (S&P, Moody’s) made the ridiculous call to lower the ratings of firms whose stock price was under pressure (thus requiring firms to come up with additional billions) based on lowered stock prices as justification—despite the basic fundamental soundness of the firm in question. Here again panic, not rational thought proved that the “professionals” are oft more easily panicked that the main-street investor.

Yes, there will be adverse selection from those few money funds who fucked up and are absolutely, positively fated to break the buck. But most aren’t. This isn’t health insurance. Most money funds do not have terminal cancer. Most money funds are fine. Thing is, in the current market, even the more-conservatively managed ones are worried about facing a run.

A money fund’s holdings mature fast (generally you’ve got 30% of your cash back within a week or so), but not so fast that you can’t be forced to sell to meet redemptions. Normally, you just sell and all is fine, but on some things there have been no bids out there, like on Frannie paper, despite the fact that it currently is guaranteed by the US taxpayer. If you can’t sell a Treasury-alike, a run will kill you.

Simply presenting the existence of this insurance immediately props things up. If need be, the Treasury will take the paper (which, as noted, in some cases the Treasury itself already guarantees). Redemptions no longer are a problem.. and so there is no need for a run.

The current situation is less like adverse selection, and more like the FDIC. No FDIC means bank runs, panics and attendant vicious cycles. FDIC means none of that. Yes, in the long run with poor regulation it also means the S&L crisis and the RTC, but I am pretty sure that isn’t what your post was about. You posited an equivalence to health insurance, and that just isn’t there.

Full disclosure: I’ve worked in the investment business since ~1993 and my current employer has ~$200B in money-market assets. And—not that it matters—we didn’t break the buck, and unlike several competitors (google for the names) we didn’t have to inject cash to prop up NAV.

One of the reasons given for the dissolution of Glass-Steagall was that our own financial entities could not compete with institutions in the rest of the world who were not so encumbered, and therefore larger by many orders of magnitude than US based institutions with which they were in competition. Yet I can remember in the late eighties/early nineties when the bloom began to come off the Japanese economy, brokers advised their customers to steer away from money market funds that had a significant composition of CD’s held by Japanese Banks. The reason? Japanese banks—hybrids of commercial and investment banks—had significant exposure to the dissolving Japanese real-estate bubble.

Sooo———it seems to me that the present “fix” while not a total illusion, is not the be all and end all. It will require a change in the corporate “culture” of these institutions as well as the proposed legal/regulatory ones. Suggestions as to how to accomplish THAT would require me to type more words than anyone here wants to read.
But it is enough to say that many of the same sort of people responsible for this mess are simply walking across the street to
work for the newly merged institutions that absorbed their own.

Yep—that’s what I’d expect. Funds will all sign on and then go for the highest returns and highest risks that regulators will allow.

If the premium is supposed to be a function of the risks of the fund, then someone needs to be able to calculated the risk. I doubt the government will be able to do that. If it’s the fund itself, then obviously there is every incentive to minimize one’s risk.

Another way to phrase it is that there is some public information, which both parties have. Then there is private information, which only one party has. Adding onto that is the fact that the corporations will have put in far more lawyer/accountant/financial expert person-hours on their own situation than the government could (unless the government goes out and hires all of the laid-off staff from Wall Stree, which might be a good idea).

“It sounds to me as though [the proposed toxic-debt-collecting entity] is going to be wearing a big sign around its neck saying, ‘Adversely Select Against Me.’ ”