Barrons columnist Randall Forsyth is writing this week about an intriguing – and somewhat scary – proposal: That the Federal Reserve is considering placing exit fees on bond mutual funds to prevent a potential run when interest rates rise. Here is his core paragraph:
(I)t might be well that the Federal Reserve appears to be thinking about the consequences of the end — and eventual reversal — of its massive experiment in monetary stimulation. Last week, the Financial Times reported that the central bank is mulling exit fees on bond mutual funds to prevent a potential run when interest rates rise, which, given the ineluctable mathematics of bond investing, means prices fall. Quoting “people familiar with the matter,” the FT said that senior-level discussions had taken place, but no formal policy had been developed.
Forsyth says that Fed Chair Janet Yellen, when asked last week about the possible move, answered that the matter “is under the purview” of the Securities and Exchange Commission. In other words, she didn’t deny it.
That was the first I heard of the proposal. Here’s a link to the Financial Times article: ‘Fed looks at exit fees on bond funds‘ and the core paragraphs:
Officials are concerned that bond funds are becoming “shadow banks”, because investors can withdraw their money on demand, even though the assets held by the funds can be hard to sell in a crisis. The Fed discussions have taken place at a senior level but have not yet developed into formal policy, according to people familiar with the matter. …
Exit fees would seek to discourage retail investors from withdrawing funds, thereby making their claims less liquid and making a fire sale of the assets more unlikely.
The idea of exit fees wouldn’t be popular with investors, who likely would be trying to sell bond funds during an already sharp fall. The exit fee would increase their losses. I haven’t seen any indication how large a fee is being considered.
Interest rates are likely to rise over the next two years. And if bond yields rise, and prices fall, bond-fund holders will benefit from the higher yields, eventually regaining the lost asset value. A sharp decline in bond prices could actually create a buying opportunity, just as many people are selling out.
But an ‘exit fee’ proposal seems to indicate the Fed and SEC are worried about a market reaction to higher interest rates and the potential of a ‘crash’ in the bond market. And that worries me.