Federal Reserve to use money markets to drain liquidity
- Source: Fed in Talks With Money Market Funds to Help Drain $1 Trillion Bloomberg, February 11, 2010
The Federal Reserve is in talks with money-market mutual funds on agreements to help drain as much as $1 trillion from the financial system as policy makers prepare for the first interest-rate increase since June 2006, according to a person familiar with the discussions.
The central bank is looking to the $3.2 trillion money- market mutual-fund industry because the 18 so-called primary dealers that trade directly with the Fed have a capacity limited to about $100 billion, estimates Joseph Abate, a money-market strategist at Barclays Capital in New York.
Money-market funds may welcome the opportunity to trade with the Fed after the financial crisis reduced the supply of safe assets in which they can invest. In one example of demand for such assets, auctions on four-week Treasury bills have attracted an average of $5.47 in bids for every dollar sold this year, compared with an average of $3.77 last year, according to Bloomberg data. Yields on the four-week bill fell to five basis points from 20 basis points a year ago.
“There are lots of great credit stories, but the option of going with the Fed and the government -- it takes away part of the risk,” said Deborah Cunningham, a chief investment officer at Federated Investors Inc. in Pittsburgh, which manages $318 billion in money-market investments. Conversations with the Fed “seem pretty positive,” she said, adding that the Fed and the industry should be in a position to conduct operations before the end of the year.
Chairman Ben S. Bernanke yesterday charted ways the Fed might withdraw record monetary stimulus pumped into the economy to fight the recession. Among the central bank’s tools are reverse repurchase agreements, in which the Fed sells securities with the intention of repurchasing them at a later date.
The Fed is also considering reverse repurchase agreements with mortgage lenders Fannie Mae and Freddie Mac, said the person familiar with the discussions. Freddie Mac spokeswoman Sharon McHale declined to comment. Fannie Mae spokesman Brian Faith also declined to comment.
“To further increase its capacity to drain reserves through reverse repos,” Bernanke said, the Fed is “in the process of expanding the set of counterparties with which it can transact” beyond primary dealers of government securities.
The primary dealers, which are required to bid at auctions of Treasury notes and trade directly with the New York Fed’s markets desk, include BNP Paribas Securities Corp., Banc of America Securities LLC and Goldman Sachs & Co.
Bernanke repeated yesterday that while interest rates are likely to stay low for an “extended period,” the Fed in “due course” will need to “begin to tighten monetary conditions to prevent the development of inflationary pressures.”
The central bank has created more than $1 trillion in excess reserves in the banking system through its purchases of $300 billion of Treasury debt and $1.25 trillion of mortgage- backed securities. To put upward pressure on the federal funds rate, the Fed may need to drain as much as $800 billion, Abate estimates.
One potential tightening tool is the interest rate on reserves that commercial banks keep on deposit at the Fed. By raising that rate, the central bank “will be able to put significant upward pressure on all short-term interest rates,” Bernanke said.
The Fed can also use reverse repos to shrink the quantity of reserves, which in turn gives it “tighter control over short-term interest rates,” he said.
Fed officials face the risk that when they start to tighten policy by raising the rate they pay banks on reserves, other market rates may not follow. That would keep monetary conditions too loose in an expansion.
“They still seem nervous that they might not be able to control short rates, and if they can’t control short rates, how do they tighten?” said Mark Spindel, chief investment officer at Potomac River Capital LLC, which manages $200 million in Washington.
The Fed has sought to keep the benchmark rate in a range of zero to 0.25 percent since December 2008. The federal funds rate is now 0.13 percent, even though banks can earn 0.25 percent by keeping their money on deposit at the Fed.
One reason for the discrepancy is that Fannie and Freddie have become “significant sellers” of funds in the overnight market and aren’t eligible to place cash on deposit at the Fed, according to a December research paper by the New York Fed.
Some hurdles remain in the Fed’s efforts to secure bigger repo capacity. Fed officials and mutual-fund industry representatives are working on a structure that would allow funds to invest in relatively liquid assets that can be sold in seven days, while allowing the central bank to avoid having to renew billions of dollars in transactions each week.
“There needs to be liquidity,” said Cunningham of Federated. “A reverse repo contract is not considered to be liquid in the context of anything beyond seven days.”
US regulatory appoach
- Source: Money Market Fund Reform in the United States The Harvard Law School Forum on Corporate Governance and Financial Regulation] June 20, 2010
Editor’s Note: This post comes to us from Andrew J. Donohue, Director of the Division of Investment Management at the Securities and Exchange Commission, and is based on a recent keynote address by Mr. Donohue to the Annual Policy Seminar of the European Fund and Asset Management Association, the full text of which is available here. The views expressed in the post are those of Mr. Donohue and do not necessarily reflect those of the SEC, the Commissioners or the Staff.
Money market fund reform continues to be an area of great importance to money market investors and the capital markets on both sides of the Atlantic Ocean. In the United States alone money market funds today hold approximately $2.9 trillion of assets  and they comprise over 25 percent of all U.S. mutual fund assets.  U.S. and European based money market funds play a critical role in the U.S. and the world economy, and although they may have taken somewhat different paths in their economic and regulatory development in Europe, there are more similarities than differences.
In the United States, for instance, money market funds arose as a cash alternative to bank deposits principally for retail investors during the 1970s when interest rates were high but regulatory requirements capped interest rates banks could pay on deposits.  In this way, money market funds fulfilled a retail niche by providing a relatively high market-driven rate of return to investors with an expected high degree of safety. Since then the industry and its investor base have changed. Now, about two-thirds of money market fund assets are in institutional money market funds (or classes), and U.S. money market funds now provide institutional as well as retail investors with an important cash management tool.
Money market funds have grown from a convenience provided by fund managers who primarily offer equity and bond funds to becoming the primary engine for a substantial portion of the short-term credit in the U.S. economy.
This includes over 40 percent of outstanding commercial paper and approximately 65 percent of short-term municipal debt.
Another significant development among U.S. money market funds is their concentrated nature: over 70 percent of all money market fund assets reside in the top ten money market fund complexes; for institutional money market funds, including tax-free funds, over 75 percent of assets are held in the top ten complexes.  I understand that in Europe, on the other hand, money market funds started primarily as institutional investments and have only recently moved into the retail space. 
President's Working Group publishes report on money markets
- Source: President’s Working Group on Financial Markets Releases Money Market Funds Report US Treasury, October 21, 2010
The President's Working Group on Financial Markets (PWG) today released a report detailing a number of options for reforms related to money market funds. These options address the vulnerabilities of money market funds that contributed to the financial crisis in 2008. Following the crisis, the Treasury Department directed the PWG to develop this report to assess options for mitigating the systemic risk associated with money market funds and reducing their susceptibility to runs. The PWG agrees that, while a number of positive reforms have been implemented, more should be done to address this susceptibility.
The PWG now requests that the Financial Stability Oversight Council (FSOC), established by the Dodd-Frank Wall Street Reform and Consumer Protection Act, consider the options discussed in this report and pursue appropriate next steps. To assist the FSOC in any analysis, the Securities and Exchange Commission, as the regulator of money market funds, will solicit public comments, including the production of empirical data and other information in support of such comments. A notice and request for comment will be published in the near future.
Today's release is one part in a series of steps that the regulatory community will be taking in the coming months to implement financial reform and to help ensure that the financial system continues to become more resilient.
The full report is available at the link here
- A Proposal for Money Market Fund Reform Economics of Contempt, November 28, 2010
- President’s Working Group Details Further Reform Options for Money Market Funds K&L Gates, November 8, 2010
SEC issues "no-action" letter on required rating agency designations
- Source: Money Market Funds Can Rely on Credit Rating Agencies Financial Planning, August 24, 2010
The Securities and Exchange Commission has given money market funds a reprieve from the Dodd Frank Wall Street Reform and Consumer Protection Act.
The act had required the commission to review its regulations that reference credit ratings and to modify regulations the Commission has identified to remove any requirement that funds rely on credit ratings. In the agencies place was to come "a standard of creditworthiness the commission determines appropriate."
In an August 19 letter to the Investment Company Institute, the Washington, D.C. trade association representing mutual funds, the SEC said, however, that money market funds do not have to follow Section 939A of the reform bill setting up the standard until further notice.
That section would have overridden an amendment to Rule 2a7 of the Investment Company Act of 1940, the regulation affecting investment funds.
Among the amendments adopted in January 2010 was one that said the boards of money market funds must designate at least four nationally recognized statistical rating organizations (NRSROs), whose ratings they could use to determine the eligibility of portfolio securities.
Because the money market funds needed to disclose the names of those NRSROs in their statements of additional information by December 31, 2010, they would likely have to come up with the names of the four NRSROs this fall.
- No-Action Watch: Dodd-Frank’s Credit Ratings Clash, Continued Westlaw Business Currents, September 3, 2010
SEC adopts amendments to money market fund rules
- Source: SEC Adopts Amendments to Money Market Fund Rules K&L Gates, March, 2010
The Securities and Exchange Commission (“SEC”) has adopted amendments to the rules governing money market mutual funds (“money funds”) registered under the Investment Company Act of 1940, as amended (the “1940 Act”). In response to the extreme turbulence in the money fund sector in 2007 and 2008, the amendments seek to reduce money funds’ vulnerability to loss. The SEC adopted most of the amendments that it proposed in June 2009, which mostly track recommendations made by the Investment Company Institute Money Market Working Group and submitted to the SEC on March 17, 2009. The amendments establish new liquidity standards and increase money funds’ obligations relating to the designation of ratings organizations and reporting. The SEC believes the amendments will make money funds more resilient to certain short-term market risks, and will provide greater investor protection if a fund is unable to maintain a stable net asset value (“NAV”). The revised rules also would permit a money fund that has “broken the buck” (i.e., priced its securities below a stable NAV per share, typically $1.00) to suspend redemptions, thereby allowing the orderly liquidation of the fund’s assets.
- New Mark-to-Market Rules for Money Funds Mark To Market Debate, May 5, 2010
Amendments to money market rules effective May 5
- Source: Amendments To Money-Market-Fund Rules Effective May 5 - SEC Wall Street Journal, February 23, 2010
Amendments meant to make the $3.3 trillion money-market fund industry more resilient will take effect May 5.
The Securities and Exchange Commission posted the final amendments, which it says offer additional shareholder protections, to its Web site Tuesday with the effective spring date. However, the posting also lists various compliance dates for the amendments, giving funds extra time to meet some requirements, such as disclosing certain portfolio information on a public Web site and to the commission.
In staggering the compliance dates, the SEC appears to be making an effort to accommodate the funds' normal schedule of meetings and oversight, said Peter Crane, president of Crane Data LLC.
Money-market funds must comply with amendments related to portfolio quality, maturity, liquidity and repurchase agreements by May 28. Funds are not required to dispose of portfolio securities they own or terminate repurchase agreements already entered at that time, however. They must the new requirements for maximum weighted average maturities and weighted average life limits for their portfolios by June 30.
"There was some speculation that the maturity and liquidity provisions would be pushed out to later this year to coincide with potential interest rate hikes, but this means that most of the changes will likely go into effect before the Fed starts hiking rates," said Crane. "So money funds could feel that bite a little bit."
Funds must post portfolio information as required under the amendments on a public Web site by Oct. 7. "This should provide each fund sufficient time to revise its information and other systems to ensure that required information is accurately posted and maintained on its website," the SEC said.
In addition, funds must being filing portfolio information, as required under the amendments, to the SEC no later than Dec. 7.
Funds must disclose by Dec. 31 the designated ratings agencies they'll look to when they are required to consider credit ratings. The additional time should permit fund boards time to evaluate and designate ratings agencies without the need to call a special board meeting, the SEC statement said.
They must be able to process transactions at prices other than a stable $1 net asset value no later than Oct. 31, 2011. "Systems personnel will be pleased that they have a little time to deal with that nasty issue," said Crane.
Overall, money funds aren't likely to be surprised by the schedule, he said. "They were gearing up for it anyhow. I think money funds are resigned to their fate at this point."
- SEC Issues No-Action Letter, Allows Putting NRSRO Designations on Hold Crane Data, August 23, 2010
The SEC Proposed Rule
The Securities and Exchange Commission is proposing amendments to certain rules that govern money market funds under the Investment Company Act.
The amendments would:
- (i) tighten the risk-limiting conditions of rule 2a-7 by, among other things, requiring funds to maintain a portion of their portfolios in instruments that can be readily converted to cash, reducing the weighted average maturity of portfolio holdings, and limiting funds to investing in the highest quality portfolio securities;
- (ii) require money market funds to report their portfolio holdings monthly to the Commission; and
- (iii) permit a money market fund that has “broken the buck” (i.e., re-priced its securities below $1.00 per share) to suspend redemptions to allow for the orderly liquidation of fund assets.
In addition, the Commission is seeking comment on other potential changes in our regulation of money market funds, including whether money market funds should, like other types of mutual funds, effect shareholder transactions at the market-based net asset value, i.e., whether they should have “floating” rather than stabilized net asset values.
The proposed amendments are designed to make money market funds more resilient to certain short-term market risks, and to provide greater protections for investors in a money market fund that is unable to maintain a stable net asset value per share.
Comments should be received on or before September 8, 2009.
- Source: SEC Proposes Rule Amendments to Strengthen Regulatory Framework for Money Market Funds SEC release, June 30, 2009
Andrew J. Donohue, Director of the SEC's Division of Investment Management, added, "The amendments proposed by the Commission today go a long way in addressing the most significant issues raised during the past two years for money market funds and their investors. They are designed to help protect funds from the most troublesome areas of risk, and to enable investors and the Commission to obtain important information about funds."
The proposed amendments would, among other things:
- Require that money market funds have certain minimum percentages of their assets in cash or securities that can be readily converted to cash, to pay redeeming investors.
Shorten the weighted average maturity limits for money market fund portfolios (from 90 days to 60 days).
- Limit money market funds to investing in only the highest quality securities (i.e., eliminate their ability to invest in so-called "Second Tier" securities).
- Require funds to stress test fund portfolios periodically to determine whether the fund can withstand market turbulence.
The proposals also would:
- Require money market funds to report their portfolio holdings monthly to the Commission and post them on their Web sites.
- Require funds to be able to process purchases and redemptions at a price other than $1.
- Permit a money market fund that has "broken the buck" and decided to liquidate to suspend redemptions while the fund undertakes an orderly liquidation of assets.
- In addition, the SEC is seeking comment on other issues related to the regulation of money market funds, including whether money market funds should, like other types of mutual funds, effect shareholder transactions at the market-based net asset value (i.e., whether they should have "floating" rather than stabilized net asset values), and whether to require that funds satisfy redemption requests in excess of a certain size through in-kind redemptions. The Commission may propose further amendments after it considers the comments it receives on these matters.
The SEC also is seeking comment on other issues, including alternatives with respect to the role of credit rating agencies in money market fund regulation.
SEC adds disclosure and liquidity requirements
- Source: U.S. SEC bolsters money market fund rules on risk, liquidity Reuters, January 27, 2010
U.S. securities regulators adopted rules aimed at making money market funds a safer investment after the collapse of the Reserve Primary Fund triggered a run on the $3.24 trillion market in 2008.
The Securities and Exchange Commission voted 4-1 on Wednesday to bolster the funds’ liquidity, limit their riskier investments and to show investors the funds may not always maintain a stable $1 share value.
The fund industry was pleased the new rules were less restrictive than the agency initially proposed last year, but the new rules were likely to come at the expense of some yield.
Money market funds were considered as safe as cash until the collapse of Lehman Brothers pushed the value of the Reserve Fund money market fund below $1 a share and forced the federal government to create a program to backstop the market.
“One of the key lessons of the financial crisis is the need for strong liquidity buffers in money market funds,” said SEC Chairman Mary Schapiro, adding the new liquidity rules would help ensure investors are able to get their money out of a fund.
Under the new rules, net asset value — or value of each share of a money fund — would be disclosed on a 60-day lag basis and allow investors to follow a fund’s share price.
Under typical industry practices, money market funds offer shares at one dollar, even if the market value of a fund’s assets are a few tenths of a cent above or below a dollar.
The enhanced disclosures would let investors see which funds are taking risks and potentially push fund managers to take fewer risks that might cause wide variations to the true net asset value.
The SEC is also requiring money market funds to hold a minimum of 10 percent of their assets in liquid securities and shortening the average maturity of debt the funds can hold to 60 days from 90 days.
Under the new rules, funds would only be allowed to invest a maximum of 3 percent in second-tier securities, such as commercial paper that is rated at the second-highest level. Previously the limit was 5 percent. The portfolio rules go into effect as early as May.
Last year the SEC had proposed completely prohibiting funds from investing in second-tier securities.
“It’s positive across the board,” said Deborah Cunningham, executive vice president at Federated Investors Inc, the third-largest money market manager. The SEC “re-thought some of their proposals and have compromised to some degree.”
Still, the new rules were likely to hurt fund returns.
Fidelity Investments, the largest money market manager, has estimated that shortening average maturities to 60 days from 90 days would reduce yields on a typical retail fund by as much as one-tenth of one percentage point.
JPMorgan Chase is the No. 2 manager of such funds.
Commissioner Kathleen Casey was the sole dissenter, arguing the new rules did not go far enough in some cases and went in the wrong direction in others. Casey was opposed to one of the rules that relied on credit ratings and said it “further embeds” the use of credit rating agencies.
The Republican commissioner has advocated removing a requirement that money market funds hold securities that are highly rated. But that has met stiff opposition from the mutual fund industry and other commissioners, who say the rating requirement acts as a floor.
The SEC is examining other money market reforms, including a floating NAV, which would reflect actual assets held. A floating NAV could drive investors out of the funds and into other financial products.
The SEC is also looking at real time disclosure of the net asset value, a private facility to provide liquidity to money market funds in times of stress and a two-tiered system for more conservative money market funds which would have stringent limits on risk-taking and a backstop requirement
- The SEC v. Investors Wall Street Journal, February 3, 2010
SEC votes to allow suspensions in redemptions of money markets
- Source: Suspending Money Market Redemptions Is Now Legal; SEC Approves New Money Market Regulation In 4-1 Vote ZeroHedge, January 27, 2010
Zero Hedge discussed a month ago the disastrous prospects of what would happen if the new proposal contemplated by the SEC, which would allow the suspension of redemptions from Money Market Funds, were to pass. Well, in a nearly unanimous vote, Money Market Funds now have the ability to suspend redemptions, courtesy of the SEC's just passed 4-1 vote. This explains the negative rate on bills: at this point, should there be another meltdown, money market investors will not, repeat not, be able to withdraw their money purely on the whim of Mary Schapiro. As the SEC noted: "We understand that suspending redemptions may impose hardships on investors who rely on their ability to redeem shares." Too bad investors' hardships considerations ended up being completely irrelevant.
- The SEC “Reforms” Money Market Funds but Votes to Allow Funds to Suspend Redemptions Registered Rep, January 27, 2010
Goldman argues for use of historical pricing in MM
- Source: Goldman Sachs Wimps Out in Buck-Breaking Brawl: David Reilly Bloomberg, February 3, 2010
"Throughout the financial crisis, Goldman Sachs Group Inc. extolled the use of market prices to value holdings, saying this instills needed discipline. The firm’s hard-line stance turned to mush, though, when it came time to end a market myth that fueled 2008’s meltdown.
Goldman, along with the mutual-fund industry, argues that it is fine for money-market funds to use historical values, rather than market prices, to value holdings. This helps money- market funds maintain a stable price of $1 a share.
The problem: the $1 share price gives investors the false impression that money-market funds are like bank accounts and so can’t lose money. That myth was shattered in 2008, and the resulting panic worsened the credit crunch, forcing the government to backstop these funds.
In the face of opposition from the fund industry and from firms such as Goldman, the Securities and Exchange Commission so far has failed to force the $3.3 trillion money-market industry to face reality by requiring the funds to show that their shares rise and fall in value, even if by miniscule amounts. This inaction creates the possibility of future market runs and the need for more government bailouts.
At a meeting last week, the SEC endorsed beefed-up disclosures for money-market funds, along with other technical changes such as requiring funds to boost cash holdings. It stopped short, though, of even proposing that funds be required to post values that wouldn’t always neatly show up as $1 a share..."
SEC said to drop plan to bar money funds from lower-rated debt
- Source: SEC Said to Drop Plan to Bar Money Funds From Lower-Rated Debt Bloomberg, January 27, 2010
U.S. securities regulators are abandoning a plan to ban money-market mutual funds from buying anything other than the most highly rated debt after companies said the requirement would hurt the commercial-paper market, three people familiar with the matter said.
The Securities and Exchange Commission will vote today to cut the so-called tier two securities money funds can buy, instead of barring purchases as proposed in June, said the people, who declined to be identified because the agency’s plans aren’t public. Current SEC rules allow funds to invest up to 5 percent of their assets in debt that carries the second-highest rating from Moody’s Investors Service or Standard & Poor’s.
The SEC recommended new rules six months ago to increase the liquidity and stability of money-market funds after the collapse of the $62.5 billion Reserve Primary Fund in 2008 raised concerns about whether the industry could meet investor redemptions during financial panics. The agency changed its proposal after the U.S. Chamber of Commerce, Time Warner Inc. and Comcast Corp. said in comment letters that the ban on lower- rated assets would make it harder for companies to fund payrolls and other short-term expenses through sales of commercial paper.
“They are really fighting and clawing over inches,” said Peter G. Crane, president of Westborough, Massachusetts-based Crane Data LLC, which tracks money-market funds. “The vast majority of the changes that the SEC proposed and likely will adopt, most of the industry has been adhering to already.”
Money-market funds are attractive because they let investors deposit and withdraw money on short notice while generating better returns than bank accounts. The $3.24 trillion industry is among the biggest buyers of commercial paper, short- term securities that companies sell to meet their funding needs.
The SEC has also scrapped a June proposal that would have imposed different requirements on money-market funds depending on whether they cater to corporate investors or individuals, the people said. As a result, all money-market funds will face a more stringent requirement that they be able to sell at least 10 percent of their assets in one day and 30 percent within a week, the people said. SEC spokesman John Nester didn’t return a call seeking comment.
Asset managers, in comments to the SEC, argued the distinction between institutional and retail funds was impractical because those catering to corporations and pension funds often hold assets from individual investors through banks or brokerages.
“That was the most difficult proposal as to how you can” implement it, Debbie Cunningham, head of taxable money-market funds at Pittsburgh-based Federated Investors Inc., said in an interview.
Net Asset Value
Money-market funds maintain a stable net asset value of $1 per share, giving investors confidence they won’t lose money. SEC officials have said the $1 share price may encourage flight at the first sign of trouble, because investors who pull money first can escape with their cash and saddle others with debt.
The President’s Working Group on Financial Markets, whose members include the leaders of the SEC and Treasury Department, is weighing the idea of requiring money funds to float their share prices. Industry groups including the Washington-based Investment Company Institute oppose a floating share price, and the SEC hasn’t proposed such a step.
Concern that regulators may favor a so-called floating net asset value heightened in the past week after President Barack Obama embraced Paul Volcker’s plan to ban proprietary trading by banks, signaling the former Federal Reserve chairman’s growing clout in policy debates, Crane said. Volcker has been a critic of the funds, saying they undermine the strength of the U.S. financial system.
The SEC rules “are seen as a necessary evil because you have to do something,” Crane said. “People are more concerned about the President’s Working Group and the re-emergence of Paul Volcker. There’s still a slim chance of radical change.”
As the SEC moves to implement reforms, money-market funds have been pursuing their own changes.
Money managers including Boston-based Fidelity Investments and Vanguard Group Inc. in Valley Forge, Pennsylvania, have worked for months on a proposed Liquidity Exchange Bank that would provide emergency cash to funds in a crisis. According to preliminary plans, the bank could buy securities at face value from funds needing cash to meet withdrawal requests. It could also apply for emergency support from the Fed’s discount window.
SEC hires former fund manager to oversee money markets
- SEC taps ex-Janus manager to oversee money market funds Investment News, January 11, 2011
The SEC has hired a former Janus Capital Group Inc. portfolio manager to help oversee the $2.8 trillion money market fund industry, a new position.
Sharon Pichler, a 13-year veteran, officially started at the Securities and Exchange Commission on Nov. 22 as a senior financial analyst and money market fund specialist. When contacted by InvestmentNews,Ms. Pichler — who ran a number of money market funds at Janus until she retired in 2007 — confirmed her position at the SEC but referred further comment to the agency’s press office, which didn’t return calls by press time.
The SEC last year passed regulations that raised the liquidity requirements on money funds, which ultimately required someone dedicated to overseeing that effort, according to people familiar with the situation. Until now, Robert Plaze, associate director of the SEC’s Division of Investment Management and co-chairman of the money market fund subgroup of the President’s Working Group on Financial Markets, has been the agency’s sole expert on money market funds.
Reserve Fund collapse
- Many U.S. money funds were at risk during crisis, Moody's report says Washington Post, August 11, 2010
Regulation after the Reserve Primary Fund collapse
Source: Bloomberg June 24, 2009
June 24 (Bloomberg) -- The U.S. Securities and Exchange Commission proposed rules aimed at preventing losses for money- market fund investors after last year’s collapse of the Reserve Primary Fund triggered a run on the $3.8 trillion industry.
The agency’s commissioners voted 5-0 today to seek public comment on a plan to require that funds hold more liquid assets and cut the average maturity of securities in their portfolios. The proposals resemble recommendations made in March by the Investment Company Institute, a Washington-based industry group.
“The commission is considering proposals that would strengthen money-market fund regulation,” SEC Chairman Mary Schapiro said at a meeting in Washington. “Because these funds are securities products, they are not immune from” losses.
The SEC has been considering rules for money-market funds since the $62.5 billion Reserve Primary was forced to liquidate amid losses on debt issued by Lehman Brothers Holdings Inc., the investment bank that failed in September. The agency is trying to reduce the chances of funds’ values falling below $1 a share and make them a more stable source of financing for U.S. firms.
Money-market funds, used by individuals and institutions as an alternative to bank accounts, let investors deposit and withdraw cash on short notice. They are among the biggest buyers of commercial paper issued by banks and other companies and can typically hold only fixed-income securities within 397 days of maturity.
The SEC proposal would require funds whose institutional investors include companies and public pension funds to make sure at least 10 percent of their assets could be sold in one day and a minimum of 30 percent could be divested within a week.
Cash would have to make up 5 percent of assets for funds with individual investors and 15 percent of the portfolio would have to be in holdings that could be sold within a week.
The SEC proposed that the maximum weighted-average maturity of all holdings for money-market funds drop to 60 days from 90. Money funds would also be prohibited from investing in securities that don’t receive top rankings from ratings companies. Currently, the SEC permits 5 percent of a fund’s assets to be lower-rated securities.
To prevent losses during runs, the SEC proposal would authorize a fund’s board of directors to bar investors from selling their shares when the net-asset value falls below $1.
SEC staff will seek public comments on the proposals for 60 days before determining whether to make any changes. Any rules must be approved in a second vote by commissioners to become binding.
Money funds aren’t required to value their holdings at current market prices, except to reflect a permanent markdown. That lets them maintain a constant net-asset value, or NAV, and sell and redeem shares at $1 apiece. Funds drop below $1 a share when permanent losses exceed 0.5 percent of net assets, forcing the NAV to be rounded down to 99 cents.
President Barack Obama’s administration, in a plan for overhauling financial regulation released June 17, called on government agencies including the SEC, the Treasury Department and the Federal Reserve to review whether money funds should adopt a floating NAV. The Obama proposal also requested study of ways money funds could obtain access to “emergency” funding from “private sources.”
Sign of Trouble
Andrew Donohue, director of the SEC unit that oversees money managers, said in an April speech that the stable $1 share prices encourages investors to flee money funds at the first sign of trouble.
If a fund suffers even a small loss, withdrawals by large institutional investors can force a fund to fall below $1 a share. The fastest-moving shareholders can escape with all their money while slower ones get stuck with losses, Donohue said.
The SEC plans to ask investors and fund companies about a floating net-asset value, which was not among the rule proposals commissioners voted on today. Some asset managers, including Legg Mason Inc. Chief Executive Officer Mark Fetting, fear such a change would reduce the attractiveness of money funds.
Fetting, in a May 8 interview, pledged to “fight it very hard.”
Robert Plaze, an associate director in the SEC’s investment management division, said the agency is proceeding cautiously in considering a floating share price because of the potential consequences for an industry that manages “about $4 trillion.”
“A lot of companies rely on money-market funds to fund their short-term financing needs,” Plaze said. “We don’t want to make a precipitous move without fully understanding what the implications are.”
SEC Commissioner Kathleen Casey criticized an aspect of the agency’s plan that she said would increase funds’ reliance on “discredited” credit-ratings companies.
Moody’s Investors Service, Standard & Poor’s and Fitch Ratings have drawn fire from investors and lawmakers who claim they contributed to the financial crisis by assigning mortgage bonds their highest AAA rankings and maintaining those assessments months after loans began defaulting in 2007.
Under the SEC proposal issued today, the agency will seek public comment on whether money-market fund boards of directors should have to designate companies whose ratings they rely on in determining whether funds can hold certain securities.
“If the commission were to adopt this approach, we would be going absolutely in the wrong direction,” said Casey, a Republican. She noted that Obama’s regulatory plan urges agencies to reduce use of ratings “wherever possible.”
The SEC will solicit comments on whether it should strip references to ratings in its money-market rules. The agency never acted on a similar proposal made last year.
The SEC said it will also ask whether it should revise rules that allow money-market funds to purchase debt securities backed by mortgages and other loans.
Such investments have drawn scrutiny after Baltimore-based Legg Mason and other companies spent billions of dollars propping up money-market funds that purchased debt issued by so- called structured investment vehicles.
“Certain types of asset-backed paper haven’t performed well, but that’s a tiny fraction of that sector,” said Deborah Cunningham, head of taxable money-market funds at Federated Investors Inc. “They will get a ton of comment that says, ‘No, why even consider that?’”
Reserve Fund settlement
- Source: Statement of Securities and Exchange Commission Chairman Mary L. Schapiro on the Court’s Order Adopting the SEC’s Proposed Distribution Plan in the Reserve Primary Fund Case November 25, 2009
"“We are pleased with the court’s order adopting the SEC’s distribution plan in the Reserve Primary Fund case. From the start, our goal was to return money to investors as quickly and fairly as possible and to avoid the extended quagmire of litigation that would have only served to deplete the finite pool of money used to pay investors.
“With this goal in mind, the SEC took the lead in proposing a just and equitable resolution and forging a consensus among the vast majority of investors who recognized the benefits of resolving this matter amicably.
“The proposal by the SEC advocated a pro-rata distribution plan that provides an equal payout to all shareholders who have not had their redemption requests fulfilled, regardless of when they submitted those redemption requests. It is estimated by the Reserve Fund that the amount to be returned would be 99 cents on the dollar, or more.
“Without this distribution plan, shareholders would have been racing to obtain judgments against the finite pool of funds, possibly leading to conflicting judgments by different courts and tapping into a $3.5 billion pot that had been set aside by the Fund to cover litigation costs. In fact, approximately 30 lawsuits already had been filed across the country at the time we proposed our plan. The SEC plan approved by the court eliminates these claims on the remaining assets, freeing up money to be returned to investors.
“Today’s ruling affirms our approach and should enable all investors to get back their money quickly.”
On September 15, 2008, the Reserve Primary Fund, which held $785 million in Lehman-issued securities, became illiquid when the fund was unable to meet investor requests for redemptions. The following day, the Reserve Fund declared it had "broken the buck" because its net asset value had fallen below $1 per share.
On May 5, 2009, the SEC filed fraud charges against several entities and individuals who operate the Reserve Fund for failing to provide key material facts to, and affirmatively misleading, investors and trustees about the fund's vulnerability as Lehman Brothers Holdings, Inc. sought bankruptcy protection. More significantly, in bringing the enforcement action, the SEC sought to expedite the distribution of the fund's remaining assets to investors by proposing a plan of liquidation.
In its complaint, the agency asked the court to enter an order compelling a pro rata distribution of remaining fund assets, which would release money that is currently being withheld from investors pending the outcome of approximately 30 lawsuits against the Reserve Fund, the trustees and other officers and directors of the Reserve entities.
- Source: Reserve Primary Fund Ordered to Make Pro-Rata Payout Bloomberg, November 25, 2009
" Reserve Primary investors waiting for cash from the money-market mutual fund whose September 2008 crash helped freeze global credit markets must share equally in its losses, a federal judge said.
U.S. District Judge Paul Gardephe in New York today agreed with the Securities and Exchange Commission and ordered a pro rata distribution of almost all the fund’s remaining assets. All shareholders can expect to recover at least 98.75 percent of money held in the fund when it closed on Sept. 16, 2008, according to data compiled by Bloomberg.
The decision marks the first major step by a court to clean up the mess left for investors caught in the largest money-fund failure in the industry’s 40-year history. Reserve Primary, the oldest money-market fund, became only the second such fund to drop below its traditional $1 share price, or break the buck, after it lost $785 million on debt issued by Lehman Brothers Holdings Inc.
The judge rejected claims for full recovery by investors, such as Deutsche Bank AG and online broker E*Trade Financial Corp., that made withdrawal requests before the fund’s shares fell below $1. That benefited a smaller group of investors including Ameriprise Financial Inc. that were originally told they would shoulder the entire $785 million shortfall.
The SEC is one of more than 30 regulators and investors that sued the fund and its managers.
Gardephe ordered that $83.5 million be withheld to cover “reasonable litigation expenses” incurred by the fund, its managers and State Street Corp., the fund’s custody bank. That compares with the $3.5 billion set aside in February by Reserve Management Corp., the New York-based firm that ran Reserve Primary.
The decision blocks all claims directly against the fund in order to allow for the distribution of cash. It doesn’t affect the status of claims against Reserve Management, or its managers and owners. The SEC has accused Reserve’s founder, Chief Executive Officer Bruce R. Bent, and his son, President Bruce Bent II, of fraud for allegedly misleading investors in an attempt to prevent withdrawals after Lehman filed for bankruptcy in the early hours of Sept. 15, 2008.
Reserve Primary held about $62 billion in net assets when Lehman collapsed. Investors withdrew about $10.8 billion before State Street stopped wiring them cash at about noon on Sept. 15. Withdrawal requests continued and, over the next 28 hours, the fund issued receipts promising to pay another $28 billion at a full $1 a share. The fund’s share value dropped to 97 cents, and the fund said it would liquidate, at 4 p.m. on Sept. 16.
Deutsche Bank, which held $500 million in the fund, argued it was entitled to all its principal under rules set by the Investment Company Act of 1940.
The SEC countered that Reserve Management’s share-price calculations were “fatally flawed” on the fund’s last two days of operation because managers had misinformed independent directors about the true state of the fund. The power to close a fund lies with its directors.
Deutsche Bank stands to lose about $6.25 million, according to Bloomberg calculations based on Reserve Management estimates of assets in the fund.
A separate group of investors holding $1 receipts argued in favor of the SEC’s pro rata distribution plan in order to speed the payout of the fund’s remaining money.
‘Only Viable Option’
The group, including China’s $297.5 billion sovereign wealth fund, Time Warner Inc. and International Business Machines Corp., called the SEC’s plan “the only viable option to achieve a full distribution to the fund’s investors in the near future.”
China Investment Corp., based in Beijing, had the most at stake in the court’s decision. The judgment may leave it about $66 million short of the $5.34 billion it held in the fund, Bloomberg calculations show.
Ameriprise is among the biggest winners. It will end up losing about $41.6 million, about $78.4 million less than if the $1 receipts had been honored, according to Bloomberg calculations. Ameriprise had about $3.2 billion invested in Reserve Primary on behalf of more than 325,000 customers, and $128 million of its own capital.
The Lehman losses represented about 1.5 percent of the $51.2 billion in shareholder assets on Sept. 16, after the flurry of withdrawals. Returns from holdings have added about $235 million, while legal expenses and management fees amounted to $90 million, according to Reserve Management estimates. That leaves investors with about 98.75 percent of their principal.
That amount would increase if the fund can sell its Lehman debt for any amount.
The SEC and others suing Reserve will now take closer aim at the Bents and other executives at Reserve Management.
“The next level of claims, against the managers of the fund for their personal misconduct, is a fight for another day,” Robert Skinner, an attorney for Boston law firm Ropes & Gray LLP representing Ameriprise, said in an interview.
Skinner said fraud claims “are still very much in play after the pro rata distribution of the funds.”
Reserve Primary’s closure sparked a wider run among investors who withdrew $230 billion from money-market funds within three days, according to Crane Data LLC, a research firm in Westborough, Massachusetts. That caused the market for commercial paper, where money funds provide about 40 percent of demand, to seize up. This threatened the ability of thousands of companies, including Fairfield, Connecticut-based General Electric Co., to roll over debt they use to fund short-term cash needs.
The SEC has proposed changing rules that govern money market funds to make them more stable."
- Reserve Primary Fund Distributes Assets to Investors SEC, January 29, 2010
Next run on money market funds could kill industry
- Source: Next run on money market funds could kill industry, SEC official says Investment News, October 14, 2009
"If money market funds experience another run similar to the one that happened in September 2008, the money fund industry is unlikely to survive in its current form, according to an SEC official who has done extensive work on money fund regulation.
To avert such a disaster, the Securities and Exchange Commission could finalize a proposal by the end of the year aimed at reducing money market fund risk and improving disclosures about the funds, Robert Plaze, associate director of the SEC’s Division of Investment Management, said at a panel discussion sponsored by the District of Columbia Bar Association.
Mr. Plaze also is co-chairman of the money market fund subgroup of the President’s Working Group on Financial Markets, which is to issue a report by Dec. 1 making recommendations on whether changes are necessary to reduce money fund’s susceptibility to runs.
Even if the SEC institutes new regulations, “the larger context is whether money market funds as a model will survive. And I suspect if there’s another event similar to last September they may not,” Mr. Plaze said.
The SEC is likely to change money market fund regulation in two stages, he said.
The first set of regulations will be based on the proposal issued by the SEC in June, which would require the $3.4 trillion money market industry to improve the credit quality of its holdings and ensure that the holdings are more liquid, among other things.
More sweeping rules, dealing with controversial issues like whether money market funds should have a floating net asset value instead of a fixed $1 per share value, could come next year, Mr. Plaze said.
The President’s Working Group is looking at the systemic risk that money market funds pose to the economy as a whole since they are widely used in business and municipal finance, he said, adding: “The crisis is in everybody’s mind.”
- The Reserve Claims Primary Fund Wasn't Alone in "Breaking the Buck" MoneyFundWire.co, September 7, 2010
- Protection of money market investors at risk Financial Times, September 5, 2010
Moody's on support from fund sponsors
- Source: Moody’s Investors Service Delivers Report Highlighting Sponsor Support of Money Market Funds Alston & Bird, August 11, 2010
Yesterday, Moody’s Investors Service released a report discussing both the historical and possible future support of money market mutual funds by such funds’ sponsors. The Report noted that historically, many money market funds have required support from their sponsors to avoid “breaking the buck,” a phenomenon that occurs when the net asset value of a money market fund falls below $1.00 per share. For the period beginning with the introduction of money funds in the United States in 1972 through mid-2007, “Moody’s identified no fewer than 146 funds that would have ‘broken the buck’ but for the intervention of their fund sponsor/investment management firm.”
The financial crisis brought a sharp spike in the number of money market funds requiring sponsor assistance. According to Moody’s research, “62 funds, including at least 36 funds in the US and an estimated 26 funds in Europe, received financial and balance sheet support from their sponsor or parent company during the financial crisis between August 2007 and December 31, 2009.” In all but two cases, sponsor support was sufficient to prevent shareholder losses in the funds. Most notably, the Reserve Fund’s Primary Fund, one of the oldest money market funds in the US, broke the buck in September 2008.
Despite historical sponsor support of money market funds, the Moody’s Report predicted that “the continuing ability of fund sponsors to financially support their money market funds might be challenged in the intermediate to long-term.” The Report cited a number of factors that might contribute to reduced sponsor support, including lower management fees and profit margins for sponsors due to low interest rates.
In January, the SEC approved new rules and amended some of the existing rules that govern money market funds.
European oversight of money markets
ECB publishes Euro Money Market Study 2010
- Source: Publication of the Euro Money Market Study 2010 ECB, December 21, 2010
Today the European Central Bank (ECB) is publishing a biennial report entitled “Euro Money Market Study 2010” which focuses on money market developments during the second quarter of 2010 and compares them to the second quarter of previous years.
The Euro Money Market Study 2010 relies mainly on the results of the Euro Money Market Survey 2010, which was published on 23 September 2010, and analyses these developments more in depth. The Euro Money Market Survey 2010 has been conducted since 1999 on an annual basis by the Market Operations Committee, composed by experts from the European System of Central Banks (ESCB), i.e. the ECB and the national central banks of the European Union.
CESR sets out harmonised definition
- Source: CESR sets out harmonised definition of European money market funds CESR, May 19, 2010
CESR publishes today its guidelines on a common definition of European money market funds (Ref. CESR/10-049). The guidelines aim to improve investor protection by setting out criteria to be applied by any fund that wishes to market itself as a money market fund. The criteria reflect the fact that investors in money market funds expect the capital value of their investment to be maintained while retaining the ability to withdraw their capital on a daily basis. A common definition will also help provide a more detailed understanding of the distinction between funds which operate in a very restricted fashion and those which follow a more ‘enhanced’ approach...
...CESR’s guidelines create two categories of money market fund
CESR’s guidelines set out two categories of money market fund: Short-Term Money Market Funds and Money Market Funds. This approach recognises the distinction between short-term money market funds, which operate a very short weighted average maturity and weighted average life; and money market funds which operate with a longer weighted average maturity and weighted average life.
For both categories of fund, CESR expects that there should be specific disclosure to explain clearly the implications of investing in the type of money market fund involved. For Money Market Funds, for example, this means taking account of the longer weighted average maturity and weighted average life of such funds. For both types of money market fund, this should reflect any investment in new asset classes, financial instruments or investment strategies with unusual risk and reward profiles.
The guidelines will enter into force in line with the transposition deadline for the revised UCITS Directive (1 July 2011). However, money market funds that existed before that date will be granted an additional six months to comply with the guidelines as a whole...
...3. CESR published a consultation paper setting out its proposed guidelines in October 2009 (Ref. CESR/09-850). 31 responses, from a range of stakeholders including trade associations, investment management companies and the European Central Bank, were received by the deadline of 31 December.
- CESR’s Guidelines on a common definition of European money market funds CESR, May 19, 2010
- FEEDBACK STATEMENT - CESR’s guidelines on a common definition of European money market funds CESR, May 19, 2010
CESR consultation process
- Source: A common definition of European money market funds Committee on European Securities Regulators, Consultation Paper, October 20, 2009
This paper sets out CESR’s proposals for a common definition of European money market funds. The key purpose behind a harmonised definition of ‘money market fund’ is improved investor protection.
This reflects the fact that investors in money market funds expect the capital value of their investment to be maintained while retaining the ability to withdraw their capital on a daily basis. A common definition will also help provide a more detailed understanding of the distinction between funds which operate in a very restricted fashion and those which follow a more ‘enhanced’ approach.
CESR proposes a two-tiered approach for a definition of European money market funds:
- Short-term money market funds Longer-term money market funds. This approach recognises the distinction between short-term money market funds, which operate a very short weighted average maturity and weighted average life, and
- longer-term money market funds, which operate with a longer duration and weighted average life.
The definitions will apply to harmonised (UCITS) European money market funds. CESR recommends that the same approach is followed at national level for non-UCITS money market funds which are authorised by the Member States.
In both cases specific disclosure should be required to draw attention to the difference between the money market fund and investment in a bank deposit. It should be clear, for example, that an objective to preserve capital is not a capital guarantee. Longer-term money market funds should be required to provide sufficient information to explain the impact of the longer duration on the risk profile.
The definition of money market funds will take the form of Level 3 CESR Guidelines. CESR Members have agreed that any fund labelling or marketing itself as a money market fund authorised after the introduction of these guidelines must comply with the agreed definition. Existing European money market funds will have a transitional period of 12 months after the introduction of the guidelines to comply with criteria set out in the agreed definition.
The proposed definitions of short-term and longer-term money market funds are set out in Appendix 1 to this paper.
Volcker recommends bank-like requirements on money funds
- Source: Volcker Says Money-Market Funds Weaken U.S. Financial System Bloomberg, August 25, 2009
Paul Volcker, the former Federal Reserve chairman who is an adviser to President Barack Obama, said money-market mutual funds undermine the strength of the U.S. financial system and should be regulated more like banks.
“Banks remain the functioning heart of the financial system, and they are protected and regulated,” Volcker said in a telephone interview last week from his New York office. “To the extent they have competitors that have different ground rules, kind of free-riders in my view, weakens the financial system.”
Money-market mutual funds, which first appeared in 1971, have developed into a $3.5 trillion pool of cash outside of the regulated banking industry that provides short-term funding to thousands of companies and financial institutions at rates below conventional loans. Their pivotal role in the economy was highlighted in September when the collapse of the $62.5 billion Reserve Primary Fund sparked a run by investors that in turn froze the commercial-paper market and threatened to cut off thousands of borrowers.
“They are an absolutely huge source of cash for high- quality borrowers,” Anthony J. Carfang, a partner at Treasury Strategies Inc., a Chicago financial-consulting firm, said in an interview. “They’re highly efficient and very transparent, reducing the cost of capital.”
Money funds are the largest buyer of commercial paper, a type of debt that matures within nine months that is a key source of short-term financing for businesses. The funds held $578.7 billion, or 41 percent, of outstanding commercial paper as of March 31, according to the most recent data published by the Fed. They are also buyers of bank-issued securities such as certificates of deposits and repurchase agreements.
Commercial banks had $1.46 trillion in outstanding commercial and industrial loans as of Aug. 12, according to the Fed.
The annual yield on three-month commercial paper sold by nonfinancial companies was 0.26 percent for the week ended Aug. 14, according to the Fed. Carfang estimated companies would pay 0.5 percentage points above the London Interbank Offered Rate, or about 0.92 percent, if they had to replace three-month commercial paper with bank loans.
Money-market funds can provide cheaper financing because they aren’t bound by regulations such as federal insurance requirements on deposits and reserves on loans that increase costs for banks, Volcker, 81, said. The funds, which are overseen by the U.S. Securities and Exchange Commission, should submit to the same “regulatory burden” as banks or give up accounting flexibility that lets them maintain a stable $1 share price, a chief attraction to investors, he said.
Volcker has been a vocal advocate of imposing bank-like requirements on money funds, to the dismay of asset managers as they wait for the Obama administration to issue new rules for the industry.
His proposals “would eliminate money funds as we know them,” Paul Schott Stevens, head of the Investment Company Institute, a mutual-fund industry trade group in Washington, said in March.
Fidelity Investments, based in Boston, is the largest manager of U.S. money-market mutual funds, with $506.3 billion as of July 31, according to Crane Data LLC, a research firm in Westborough, Massachusetts. Fidelity and other independent asset managers, including New York-based BlackRock Inc. and Vanguard Group Inc. of Valley Forge, Pennsylvania, oversee about half of the industry’s assets. The rest is managed by fund companies owned by banks, led by JPMorgan Chase & Co., which has $390.3 billion in money-fund assets.
Government Report Due
Money-fund managers dodged the possibility of radical change on June 24 when the SEC proposed rules changes largely in line with industry recommendations.
Another hurdle approaches on Sept. 15 when the President’s Working Group on Financial Markets, a government advisory body, is set to issue a report on the industry. The group was directed by the Obama administration in June to consider whether money- market funds should be forced to abandon the practice of maintaining a $1 net asset value, or NAV, or be required to set up “emergency liquidity facilities.”
Volcker said he isn’t involved directly with the President’s Working Group and wouldn’t speculate on what regulatory proposals may result.
“I don’t know. I’m sure the money-market funds have a very powerful lobbying machine,” he said.
Officials of government organizations participating in the working group, including the SEC, the Treasury and the Federal Reserve, declined to comment.
Group of Thirty
Volcker first aired some of his views in January when the Group of Thirty, a nongovernmental think tank that he chaired, recommended that funds offering bank-like services should be required to reorganize as special purpose banks “with appropriate prudential regulation and supervision, government insurance and access to central bank lender-of-last-resort facilities.”
Volcker, who stood by the recommendations last week, said he hadn’t personally drafted the section on money-market funds.
“In my vision of the new financial system, you obviously want to protect banks and have strong banks, and I don’t think they should be put at a competitive disadvantage vis-a-vis money-market funds,” he said.
Stevens and industry executives said money funds have proved to be a safe investment for companies and individuals while providing a reliable source of short-term funding to companies.
“Paul Volcker has a 30-year hatred of money funds and he is woefully behind the times,” Federated Investors Inc. Executive Vice President Eugene F. Maloney, whose Pittsburgh-based company is the third-largest money-fund manager, said in a telephone interview.
Volcker said his main concern stands “apart from the degree to which the funds themselves can create a problem if and when they fail.” He said he’s not worried by the idea of dismantling the biggest lender to commercial-paper borrowers.
“They do funnel money to the commercial-paper market but they are just funneling money that would otherwise go to the banks, and it’s the banks’ business to make loans to those people,” Volcker said.
Volcker is chairman of the Economic Recovery Advisory Board, a body created by Obama in February to recommend responses to the economic and financial crises. He was Fed chairman from 1979 to 1987 and has been credited with taming inflation during that period.
Unlike bond funds that mark holdings at current market prices, money-market funds value their investments according to their expected payoff at maturity, allowing them to maintain a steady $1 NAV, unless a holding defaults. Returns on investments are credited to customers and distributed monthly as cash or new shares.
The stable $1 NAV has served as one of the funds’ main draws for investors that include companies, pension funds and individuals. The $1 share price has also been labeled the greatest weakness for money funds, and a threat to the wider money markets they serve as lenders.
Andrew Donohue, director of the SEC unit that oversees money managers, said in an April speech that the stable $1 share price encourages investors to flee money funds at the first sign of trouble.
- Sympathy for the money market funds FT Alphaville, August 25, 2009
Expiration of guarantee program for money market funds
- Source: Treasury Announces Expiration of Guarantee Program for Money Market Funds US Treasury, September 18, 2009
"The U.S. Department of the Treasury today announced that the Guarantee Program for Money Market Funds (the "Program") will expire today. The Program was initially established for a three-month period that could be extended up through September 18, 2009. Since inception, Treasury has had no losses under the Program and earned approximately $1.2 billion in participation fees.
"As the risk of catastrophic failure of the financial system has receded, the need for some of the emergency programs put in place during the most acute phase of the crisis has receded as well," said Treasury Secretary Tim Geithner. "The Guarantee Program for Money Market Funds served its purpose of adding stability to the money market mutual fund industry during market disruptions last fall and ultimately delivered a healthy return to taxpayers."
Treasury designed the Program to stabilize markets after a large money market fund's announcement that its net asset value had fallen below $1 per share ("broke the buck") in the wake of the failure of Lehman Brothers in September of 2008. Maintaining confidence in the money market mutual fund industry was critical to protecting the integrity and stability of the global financial system."
- Source: Where’s the money (market funds)? FT Alphaville, September 21, 2009
Let’s be clear. The US Treasury has not suddenly decided to withdraw its guarantee on money market funds (MMFs) — the guarantee was due to expire on September 18, 2009 ever since its original implementation on September 19, 2008 was extended beyond an initial three-month period. This is not some Tim Geithner-imposed conspiracy to, in Galland’s words, “kill” the funds, which have been experiencing troubles since Lehman collapsed last year.
However, Galland does make a good point when it comes to how the decline of MMFs is impacting other asset classes.
Here’s his commentary: As of September 2009, there was $3.58 trillion in money market mutual funds, of which just shy of $2 trillion is sitting in taxable non-government funds. But that money is starting to move: over the last month, money market mutual fund redemptions have been on the rise - with assets falling by a significant 15.3%. With the government pulling its guarantee, and given the risk associated with the money market funds, I have to wonder how many more investors might also decide to pick up stakes in the days and weeks just ahead?
And where might all that money head? Most likely, given the cautious nature of money market fund holders, into FDIC-insured accounts and CDs, and into Treasury funds and instruments. That, of course, helps the banks, and it helps the government meet its aggressive funding needs, while simultaneously taking pressure off interest rates.
We’ve written before that at low interest rates, the business model of money market funds — investing in things like commercial paper, repos and short-term bonds — simply breaks down. The funds cannot pay their fees and still pay investors an attractive return at zero per cent interest rates.
Source: Money market funds may suffer when federal backstops expire, J. P. Morgan exec fears Investment News, August 25, 2009
"Money market mutual funds would benefit from a federal program to guard against the risk of illiquidity in the markets, analysts yesterday at the first Money Fund Symposium in Providence, R.I.
Liquidity in money market funds drew regulatory attention after the industry experienced a run on the market in September 2008 when The Reserve Primary Fund, offered by the Reserve Management Co. Inc. of New York, fell below its net asset value of $1.
As a result, money fund assets dropped to $3.4 trillion as of Sept. 24, 2008, from a peak of $3.6 trillion on Sept. 3, 2008, according to the Investment Company Institute of Washington.
“It shut down the ability to borrow for those who needed funding, like broker-dealers, U.S. and foreign banks,” Alexander Roever, managing director at J.P. Morgan Securities Inc. of New York, said at the conference sponsored by Crane Data LLC of Westborough, Mass.
“That became systemic risk. That makes the argument for a backstop to be put in place.”
Several federal lending facilities put in place to help support liquidity in the commercial paper market are set to expire in February.
Paul Volcker, the former Federal Reserve chairman and an adviser to President Obama, said today in an interview with Bloomberg that money market funds threaten the banking system and should be regulated in a fashion similar to banks.
In addition, the Treasury Department's Temporary Guarantee Program for Money Market Funds, set up to offer insurance to guarantee money market mutual fund deposits as of Sept. 19, 2008, is scheduled to expire next month. It is widely believed the program will not be extended.
The Securities and Exchange Commission is also seeking comments on its proposed rules to reduce risk in money funds and ensure safety for shareholders.
“The question is does the set of [Securities and Exchange Commission] proposed rules do that, and it's not clear that they do,” Mr. Roever said.
The rules include tighter liquidity requirements and would lower the weighted average of maturity for a portfolio to 60 days, from 90 days.
But if new restrictions result in lower yields, investors may pull out.
“But the [rules] may chase the investors to other places,” Mr. Roever said.
“The investors will eventually go to higher-yielding places. It could be the second coming of the enhanced cash fund market.”
Money market fund credit and liquidity risk proposals
Source: Fitch Ratings
"The money market fund industry and its various regulators are considering changes to address credit and liquidity risk in 'prime' money market funds to improve their safety and soundness, while lowering their potential systemic risk.
The timing and magnitude of these changes will determine whether ratings will be maintained at their current levels or if negative ratings actions will be necessary. Fitch will be monitoring the discussions between the SEC, the President's Working Group on Financial Markets and other industry-led groups that could result in fundamental changes that provide for greater protections against and credit liquidity risk.
While money market funds have enjoyed a long and successful track record of stability up until last year, a critical element behind their stability has been sponsor support during times of stress. Historically, there have been numerous instances of money market sponsors providing some level of support to their funds. Absent this support, it is likely that more funds would have failed to offer same-day liquidity and/or a stable NAV, particularly during the credit and liquidity stresses experienced in 2008. Without fundamental structural changes, money market funds will continue to rely on sponsor support, which may not always be forthcoming.
The financial crisis revealed structural shortcomings that, given their size and importance to the credit markets, have highlighted the systemic risks posed by money market funds. Despite holding diversified portfolios of assets that are subject to credit and market risks, money market funds do not maintain any equity or credit enhancement to absorb losses (beyond a threshold for NAV to decline by 50 basis points before 'breaking the buck').
These investment vehicles also have proven to be confidence-sensitive and exposed to contagion risk by offering same-day liquidity to shareholders which can lead to 'runs' as a result of industry or sponsor concerns. Fitch believes that more can be done to better match the liquidity profile of fund assets to shareholder redemptions. However, the level of intrinsic asset liquidity that funds could reasonably be expected to maintain on a standalone basis would be insufficient to meet the level of redemptions witnessed last year, without having access to committed sources of back-up liquidity."
- Money Funds Knock Moody's Ratings Plan Wall Street Journal, September 17, 2010
Reverse repo and money markets
- Source: Federal Reserve Eyes the US Money Market Funds Jesse's Cafe Americain, September 24, 2009
"...According to this news piece, the reason the Fed is looking to the Money Markets is that, just like Willie Sutton, that's where the money is. There, and in the 401k's, and the IRA's.
The central bank is now considering dealing with money market funds because it does not think the primary dealers have the balance sheet capacity to provide more than about $100 billion... Money market mutual funds have about $2.5 trillion under management..." To digress, please note that somewhat startling statistic. The Fed is going to the money market funds, because they think that the primary dealers among them cannot raise more than $100 billion dollar in liquid capital to take repos from the Fed, without impairing the banking system. If you look it up in the dictionary, try looking under 'fragile' or 'insolvent.'
Back on topic, there has been a longtime animosity between the banks, or at least what used to pass as a bank, and the money market funds. The funds are not covered by FDIC, are not regulated as banks, and typically pay higher rates of interest to depositors than conventional commercial banks. They tend to invest their funds in the commerical paper markets. It was the seizure of the short term paper markets that brought the money market funds to the brink, and a potential run on the funds, as fears grew that they would 'break the buck,' that is, the Net Asset Value of One Dollar for every dollar deposited.
Obviously this entire proposition is a bit puzzling on the surface, and is certain to raise fears of Fed shifting toxic assets from the banking system to the more 'public funds.' It is not a huge concern if these are truly repurchase agreements since the value of the assets will be backed 100 percent by the Fed. We would also assume that the Funds might be able to express some preference for Treasuries, rather than bundles of sludge backed by Joe Subprime Sixpack LLC.
It was also interesting today that in his testimony before the Congress which was widely ignored by the mainstream media, Paul Volcker had some very strong words about what is a bank, and what is not. Money market funds are not banks, and banks have no business using their banking platforms to fund proprietary trading operations that are merely seats at a rather risky virtual casino known as Wall Street..."
How low rates break the buck
- Source: How low rates break the buck FT Alphaville, October 31, 2009
Essentially the business model of money market funds breaks down at extremely low rates. That’s because, like the vast majority of managed investments, they take a fee for investing in securities like commercial paper, repos, short-term bonds, etc. Bank of America’s Michael Cloherty uses numbers from CraneData to show the average distribution of fees, in an excellent note out today:
He says that:
At some level of short rates, the assets that money funds buy will not throw off enough cash to pay the fees and still pay investors a reasonable income stream. At that stage, we would expect investors to begin to exit money funds…
The exact rate level at which this might happen is difficult to ascertain as it depends on 1) how much room MMFs have to cut fees and 2) what minimum payout investors are willing to accept before they walk away in favour of bank deposits or whatever. There are, however, hints, according to BoA:
…the 1% target from June 2003 to June 2004 was obviously above the floor. Over that period, the 3m funds/LIBOR spread averaged 14bps. The market is currently pricing a 156bp LIBOR/OIS spread as of the December FOMC meeting. Wider spreads indicate that prime money funds will be able to handle a lower Fed funds target, although Treasury-only money funds may not.
Fine, except that as we (and BoA) have noted, the effective Fed Funds rate (i.e. the weighted average of actual negotiated rates between banks) is below the target rate. In fact it’s been averaging 59bp below target for the month of October, according to BoA, and that leads them to conclude:
"… we would be comfortable that money fund assets will be stable at a 75bps funds rate, but believe the risks are excessive at 50bps."
In other words, at a target rate of 50bp (and an effective rate potentially lower) money market funds could be in very real danger of dipping below their $1 net asset value — breaking the buck. That would have major implications for the shadow banking system.
Recall for instance, the bleak month of September, when Reserve Primary’s buck-breaking (the second MMF to ever do so), started a run on commercial paper - a sector which is only just beginning to show signs of recovery - and only after the US bought $146bn of it.
Of course, the impact of an MMF breaking the buck would now be significantly less than before.
After Reserve Primary, the US Treasury announced it would temporarily insure MMF holdings, much like FDIC and bank deposits. Now, if an MMF breaks the buck, FDIC will restore its NAV back to $1 (with the caveat that only assets invested in the fund before Sept. 19 are covered).
The irony is that by reducing rates to save the economy as a whole, the US may be risking further bailouts of money market funds and tightened liquidity. It’s another great example of the tightrope act that is public finance.
Money fund assets rose to $3.483T last week
- Source: Money fund assets rose to $3.483T last week AP, September 25, 2009
Total money market mutual fund assets rose $198 million to $3.483 trillion for the week, the Investment Company Institute said Thursday. Assets of the nation's retail money market mutual funds fell $12.88 billion in the latest week to $1.138 trillion.
Assets of taxable money market funds in the retail category fell $9.05 billion to $890.42 billion for the week ended Wednesday, the Washington-based mutual fund trade group said. Tax-exempt fund assets fell $3.83 billion to $247.63 billion.
Assets of institutional money market funds rose $13.08 billion to $2.345 trillion for the same period. Among institutional funds, taxable money market fund assets rose $16.73 billion to $2.169 trillion; assets of tax-exempt funds fell $3.65 billion to $175.12 billion.
The seven-day average yield on money market mutual funds in the week ended Tuesday was 0.06 percent, unchanged from the previous week, said Money Fund Report, a service of iMoneyNet Inc. in Westboro, Mass. The 30-day average yield was also flat at 0.06 percent, according to Money Fund Report.
The seven-day compounded yield was 0.06, the same as the previous week, and the 30-day compounded yield was unchanged at 0.06 percent, Money Fund Report said.
Money fund run that caused the collapse of '08
- Source: Rep. Kanjorski: $550 Billion Disappeared in “Electronic Run On the Banks” Infowars.com, February 6, 2009
At 2 minutes, 20 seconds into this C-Span video clip, Rep. Paul Kanjorski of Pennsylvania explains how the Federal Reserve told Congress members about a “tremendous draw-down of money market accounts in the United States, to the tune of $550 billion dollars.” According to Kanjorski, this electronic transfer occured over the period of an hour or two.
Here is a transcript of what Kanjorski says in the video:
On Thursday Sept 15, 2008 at roughly 11 AM The Federal Reserve noticed a tremendous draw down of money market accounts in the USA to the tune of $550 Billion dollars in a matter of an hour or two.
Money was being removed electronically.
The treasury tried to help with $150 Billion.
But could not stem the tide.
It was an electronic run on the banks
The treasury intervened but had they not closed down the accounts they estimated that by 2 PM that afternoon. Within 3 hours. $5.5 Trillion would have been withdrawled and collapsed and within 24 hours the world economy.
Kanjorski does not provide further details.
- MONEY MARKETS-Big investors prefer $1-a-share money funds Reuters, January 11, 2011
- The emigration of the money market funds FT Alphaville, December 13, 2010
- Why You Should Kiss Your $1-Per-Share Money Market Fund Goodbye Moneywatch.com, December 3, 2010
- Breaking the Buck—Reducing Systemic Risks Posed by Money Market Mutual Funds IMF Direct, November 10, 2010
- Moody’s on ‘breaking the buck’ – and 208 near misses FT Alphaville, August 10, 2010
- Video: Pozen Discusses SEC Rules on Money-Market Mutual Funds Bloomberg, May 27, 2010
- Money Market Developments Credit Writedowns, May 27, 2010
- SEC Proposes Revisions to Money Market Fund Rules, K&L Gates (Pagnano, Attisano and Skerrett), July 7, 2009
- Money Funds Are Ripe for ‘Radical Surgery’ Bloomberg, July 29, 2009