John C. "Jack" Bogle is 83 and outspoken. Over the years, the Vanguard Group founder has frequently criticized the mutual fund industry that he helped nurture. In the 1970s, Bogle challenged the industry status quo when Vanguard introduced the first low-cost index funds.
He has clashed with industry leaders -- and in some instances Vanguard, today the largest fund company -- over such matters as investment tax rates and financial market reform. Then, of course, there's the size of fees that funds charge investors -- especially managed funds that, unlike index funds, seek to beat the market rather than match it.
Bogle left Vanguard's leadership ranks in 2000 but he and the industry are currently at odds over how to strengthen money-market mutual funds. Average investors and institutions use these safe-harbor investments as parking places for cash that's temporarily kept out of stocks or higher-yielding segments of the bond market. Corporate and local government treasurers use cash invested by money fund shareholders to cover short-term needs such as payroll and purchasing.
The fund industry won a victory last week when Securities and Exchange Commission Chairman Mary Schapiro conceded she lacked support to adopt new restrictions covering $2.6 trillion in money fund assets. Schapiro abandoned a scheduled vote because she couldn't secure backing from a commissioner considered a swing vote on the five-member panel.
Yet Schapiro's concession didn't end the acrimony over proposals that the Investment Company Institute and the trade group's member fund companies fought. A statement that Schapiro issued prompted commissioners Daniel Gallagher and Troy Paredes to reply with their own this week. They said Schapiro created the false impression they didn't care about strengthening money funds.
Schapiro's proposal, they said, "would impose significant new costs ... while potentially introducing new risks into the nation's financial system."
In an interview this week, Bogle said the two commissioners have it backward. Failing to adopt Schapiro's proposals, he says, is risky business.
A key issue is whether to abandon the "stable net asset value" standard for money funds, as Schapiro proposed. That's a reference to the fact that money funds are supposed to continually hold at least $1 in assets for each investor dollar put in. That feature sets money funds apart from other investments whose shares rise and fall in value.
Schapiro says the current standard gives investors the false impression that they're essentially guaranteed against losses. She also worries that the standard creates a risk that one soured investment by a fund will touch off panic among investors wanting to quickly withdraw cash.
That's what happened four years ago, when a bond investment by one money fund soured after Lehman Brothers went bankrupt. Institutional investors pulled cash from the fund, which "broke the buck" when it couldn't return a full dollar for each dollar that clients tried to pull out. The fund collapsed, and investors pulled more than $300 billion from money funds industrywide in a few days. Short-term credit markets froze and the government rescued money funds by extending temporary guarantees
Schapiro and others want to give fund managers leeway for temporary fluctuations, or a "floating net asset value" slightly above or below the dollar-for-dollar level.
Schapiro says a floating NAV would recognize that investors can sustain modest losses when markets are under stress. Research by her staff found more than 300 instances dating to the 1980s when fund companies stepped in with financial support to prevent money funds from breaking the buck.
Schapiro's critics warn that abandoning the current standard would cause investors to pull out of money funds and move cash to riskier investments, creating potential instability for the financial system.
Bogle doesn't see it that way. He was interviewed by phone from the Bogle Financial Markets Research Center, a Vanguard-financed think tank that Bogle heads at the fund company's headquarters in Valley Forge, Pa. Here are excerpts:
Q: The expectation that you can always get at least a dollar back for each dollar invested is a key reason why money funds are appealing to investors. What will happen if a floating standard is established?
A: The asset values already float, but we just hide it. There is not the kind of safety that people assume there is.
Q: After the defeat of Schapiro's proposal, Vanguard issued a statement saying it opposed the proposal because it "would have eliminated an important savings tool" implying that it would mean the end of the money fund industry. What's your reaction?
A: That's their guess, and they may know more about it than I do. But I don't see why. Investors are relying on this illusion that the asset value is fixed. We ought to do away with the illusion. I know this would be painful for the money market industry to move to a floating NAV, but it would not eliminate the industry. That's absurd. I don't think enough people are standing back and saying, "What's the reality here?"
Q: The industry is already challenged because money fund returns are currently tiny, and investors have been pulling cash out as a result. Returns have recently averaged 0.02 percent -- $2 a year for each $10,000 invested. Might tighter restrictions make things worse?
A: The industry isn't providing a competitive return now, but that will change over time. If there is a floating net asset value, people will understand that asset values do float, if only a tiny bit. And if a company runs a money fund very conservatively, you can still keep the asset value stable every day of the year.
But there's always the chance of something going wrong in this technology-driven system. After what happened in 2008, we now know that there's an immediate contagion if something happens to a money-market fund. Even though only one of the funds gets pneumonia, every money fund gets a cold.
Q: How significant a risk do you think money funds pose to the overall financial system?
A: It's hard for me to put in the context of the overall economy. It's certainly one of the major risks in the mutual fund industry. There's this kind of razor's edge, and all of a sudden you go over it, and people suddenly want their money at the previous price. It's just not sound.