#1648 1970 · The Reserve Primary Fund (Reserve Management, Bent & Brown) · Finance / asset management
A pool that wasn't a deposit—freeing savers from the legal cap on bank interest
the problem
A 1930s law capped deposit interest, so with 1969 inflation savers earned zero and had no liquid way to earn more
background
A Depression-era federal rule, Regulation Q (required by law from 1933), capped the interest that banks and other depository institutions could pay on savings deposits — around 5 percent — as a guard against runaway deposit-rate competition that had contributed to widespread bank failures. By 1969 inflation had reached roughly 5 percent, so the money ordinary households and companies parked in savings accounts was effectively earning no real return. The alternative instruments that did pay market rates — Treasury bills, jumbo certificates of deposit, commercial paper — carried minimum purchases of $10,000 or more and were far less liquid and convenient than a savings account, putting them out of reach for most savers.
In 1970, financial consultants Bruce R. Bent and Henry B. R. Brown saw the arbitrage. Rather than petition regulators or Congress to raise the deposit-rate ceiling, they created a mutual fund — the Reserve Fund — that pooled money from many savers and invested it solely in those very short-term, market-rate instruments, redeemable at any time and structured to hold a stable price near $1 a share. Because a money market mutual fund was not a bank deposit and its operator was not a depository institution, the interest cap that governed bank deposits simply did not apply to it. The first such fund launched around 1971-72, and the category grew to 36 funds by 1975 and 649 by 1990.
what everyone would do
Lobby Congress or the Federal Reserve to raise the deposit-rate ceiling, or simply accept the capped savings rate and wait for the law to catch up with inflation.
what they saw
When a rule caps your category, do not fight to change the rule—offer the same function in a category it does not govern, so the cap's letter simply stops applying to you
the move
Bent and Brown wrapped the exact market-rate securities that average savers could not afford or easily reach — Treasury bills, commercial paper, jumbo deposit-like instruments — into a pooled mutual fund that behaved like a savings account: daily withdrawals, stable dollar-value, diversified holdings. Legally it was a fund, not a deposit, so Regulation Q's interest ceiling on bank deposits never reached it. They reclassified the product out from under the rule instead of fighting to change the rule, letting small sums pool past the $10,000 minimums and earn market rates with bank-like liquidity.
why it works
The cap was anchored to a legal category — 'deposit' held by a depository institution — not to the economic job of holding idle cash safely, liquidly and at a return. By delivering that job through a mutual fund, Bent and Brown removed the gatekeeper who would have denied a higher deposit rate, because nothing was being denied: a fund was simply not a deposit, so the rule covering deposits could not reach it. Pooling dissolved the $10,000 minimums that had walled small savers off from market-rate instruments, and the stable-share, daily-redemption design gave bank-like liquidity. Savers fled the capped account for the fund, which made the product visibly more valuable than the regulated alternative — and that demonstrated worth, more than any lobbyist, is what pressured regulators and Congress to begin unwinding the deposit-rate limits in 1980 and abandon them by 1986.
the payoff
The first money-market fund created a trillions-dollar sector, helped repeal the cap law, and gave small savers liquid market-rate yield
where it breaks
The escape only holds while the rule stays pinned to the old category and no authority re-draws the boundary to capture you. Once an escapee grows large and takes on the risk the original rules existed to contain, regulators catch up — as they did when the SEC began regulating money market funds in 1977 and 1983, and more dramatically in 2008, when the Reserve Primary Fund's stable-$1 promise met actual credit losses and it broke the buck, triggering a sector-wide run the US government had to backstop. The same deregulated status that made the product a great deal also left it without the bank protections (deposit insurance, capital rules) that would have contained a failure, so the mechanism converts a regulatory advantage into concentrated, unguaranteed risk once the high returns it chases turn sour.
what came after
The Reserve Fund's product became the platform for modern cash management: money market funds grew from a handful in the early 1970s to 649 in the US by 1990, holding trillions of dollars and acting as a core alternative to bank deposits. Their presence helped pressure Congress to begin dismantling the deposit-rate caps — the Monetary Control Act of 1980 began the phase-out, and the limits were fully eliminated by 1986. The category's later fragility was exposed in 2008 when the Reserve Primary Fund itself broke the buck on Lehman commercial paper and triggered a sector-wide run that the US Treasury and Federal Reserve had to backstop.
references
- [1]Money Market Mutual FundsFederal Reserve History (Federal Reserve System), 2013federalreservehistory.org
- [2]Henry Brown, helped launch money market fund industryThe Boston Globe, 2008archive.boston.com