In a speech this morning at the Council on Foreign Relations entitled "Financial Reform to Address Systemic Risk", Federal Reserve Board of Governors Chairman Ben S. Bernanke made a number of comments on money market funds, suggesting a number of possible regulatory changes. He cited the importance of money funds and commercial paper, and called for "increasing the resiliency" of funds, not for dramatic change.

Bernanke says, "The world is suffering through the worst financial crisis since the 1930s, a crisis that has precipitated a sharp downturn in the global economy. Its fundamental causes remain in dispute .... In the near term, governments around the world must continue to take forceful and, when appropriate, coordinated actions to restore financial market functioning and the flow of credit.... At the same time that we are addressing such immediate challenges, it is not too soon for policymakers to begin thinking about the reforms to the financial architecture, broadly conceived, that could help prevent a similar crisis from developing in the future."

He continues, "The Federal Reserve and other authorities also are focusing on enhancing the resilience of the triparty repurchase agreement (repo) market, in which the primary dealers and other major banks and broker-dealers obtain very large amounts of secured financing from money market mutual funds and other short-term, risk-averse sources of funding. For some time, market participants have been working to develop a contingency plan for handling a loss of confidence in either of the two clearing banks that facilitate the settlement of triparty repos. Recent experience demonstrates the need for additional measures to enhance the resilience of these markets, particularly as large borrowers have experienced acute stress. The Federal Reserve's Primary Dealer Credit Facility, launched in the wake of the Bear Stearns collapse and expanded in the aftermath of the Lehman Brothers bankruptcy, has stabilized this critical market, and market confidence has been maintained."

Bernanke told the CFR, "Another issue that warrants attention is the potential fragility of the money market mutual fund sector. Last fall, as a result of losses on Lehman Brothers commercial paper, a prominent money market mutual fund 'broke the buck' -- that is, was unable to maintain a net asset value of $1 per share. Over subsequent days, fearful investors withdrew more than $250 billion from prime money market mutual funds. The magnitude of these withdrawals decreased only after the Treasury announced a guarantee program for money market mutual fund investors and the Federal Reserve established a new lending program to support liquidity in the asset-backed commercial paper market."

Finally, he says, "In light of the importance of money market mutual funds -- and, in particular, the crucial role they play in the commercial paper market, a key source of funding for many businesses -- policymakers should consider how to increase the resiliency of those funds that are susceptible to runs. One approach would be to impose tighter restrictions on the instruments in which money market mutual funds can invest, potentially requiring shorter maturities and increased liquidity. A second approach would be to develop a limited system of insurance for money market mutual funds that seek to maintain a stable net asset value. For either of these approaches or others, it would be important to consider the implications not only for the money market mutual fund industry itself, but also for the distribution of liquidity and risk in the financial system as a whole."

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