Money Market Funds: Safe Cash Management Vehicle or Source of Systemic Risk?
With over $2.6 trillion invested in money market mutual funds (MMFs), talk about potential risks they present to investors and global economies has generated a lot of attention across the political spectrum.
A financial instrument that seeks to maintain a stable net asset value (NAV) of $1.00 and allows investors to redeem daily, MMFs have become a mainstay of many households and a source of cash management/short-term funding by municipalities, states, companies, and financial institutions. For over 30 years, MMFs have operated without much controversy, as fund sponsors have on all but two occasions infused the funds with cash when NAV has dipped below $1.00, thus allowing them to maintain stable NAVs.
But attention to money market funds skyrocketed when, in September 2008, Reserve Primary Fund’s NAV — stung by the Lehman collapse — fell below $1.00/share (called “breaking the buck”), triggering a run on redemptions and contributing to a domino effect on global short-term credit markets. It soon ignited a debate among regulators and industry on whether Reserve Primary’s cascading effect on global credit markets was severe enough to warrant future regulatory scrutiny and changes in MMF operating procedures.
While the mutual fund industry, treasurers of state and local municipalities, and some members of Congress, among others, have called the focus on MMF risks misplaced, others appear steadfast in their commitment to change MMFs as we know them.
MMFs in Regulatory Crosshairs
Starting with the 2010 President’s Working Group Report on Financial Markets, the discussion on how to address MMF structural and systemic vulnerabilities has produced a number of options.
In championing a change to the current MMF structure, SEC Chairman Mary Schapiro notes some investors’ misconception that MMFs are government-guaranteed and thus “risk-free” investments. Moreover, she believes the vulnerability of MMFs to runs poses a systemic risk to the market. Currently under review by SEC commissioners is a proposal that would address these concerns by MMFs’ conversion to a floating NAV, or requiring them to have a capital buffer, buttressed by redemption restrictions. But while Chairman Schapiro has strongly advocated for these changes, it is unclear whether there is enough support among SEC commissioners to issue the proposal for public comment.
Systemic Risk Council Urges SEC Action
The Systemic Risk Council (SRC), which CFA Institute co-sponsors, has called upon the SEC to take just such an action. In a statement issued last week, the SRC voices support for these reforms, stating that “the risk that emergency government support may again be needed to stem large outflows from money market funds remains a serious challenge for U.S. and other markets.” Should the SEC not take prompt actions, the SRC calls upon the Financial Stability Oversight Council (FSOC) to pick up the reins.
The SRC appears to be on target with its recommendation, as this is an issue the FSOC is closely monitoring. In its annual report (on page 11) issued late last week, the FSOC explicitly cites Chairman Schapiro’s proposal, recommending that the SEC publish its proposal for public comment and “ultimately adopt reforms that address MMF’s susceptibility to runs.” And during open meeting of the Federal Reserve, Fed Chair Ben Bernanke added his voice to those calling for the proposal to be issued for comment, noting that the Federal Reserve doesn’t now have resources available should a run like the one started by Reserve Primary happen again.
The MMF industry, meanwhile, awaits a resolution.