Though the deadline for comment letters on the President's Working Group Report on Money Market Fund Reform was officially January 10, 2011, the Securities & Exchange Commission continues to post additional late entrants. The most recent addition is a letter from John Hawke, Jr., from Arnold Porter, on behalf of Federated Investors. Hawke writes, "We are writing on behalf of our client, Federated Investors, Inc. and its subsidiaries, to provide a supplemental comment in response to the U.S. Securities and Exchange Commission's request for comments on the President's Working Group Report on Money Market Fund Reform. We supplement Federated's earlier comments submitted in this docket in order to respond to a comment letter filed after the close of the comment period by The Squam Lake Group, which is a consortium of academic economists."
The letter explains, "We agree with the Squam Letter on one major point: moving Money Funds to a floating NAV is a fundamentally unsound idea that, if acted upon, would not only make Money Funds unattractive to investors, it would also significantly increase systemic risk in the banking industry. This view, that moving Money Funds to a floating NAV would be a very bad idea, is also shared by a broad cross section of other commenters representing consumers and investors, academia, businesses, business journalists, state and local governments, and investment management firms. We disagree with the Squam Letter, however, on two other basic points: (1) the premise of the Squam Letter that the current way in which Money Funds are structured and regulated is flawed and creates systemic risk; and (2) the conclusion of the Squam Letter that there is a need to fundamentally change the capital structure of Money Funds to address the alleged systemic risk."
Hawke tells us, "On the first point, the Squam Letter notes that during the financial crisis, one Money Fund, the Reserve Primary Fund, broke a buck and was forced to halt redemptions and liquidate. The Squam Letter goes on to note that 36 other Money Funds received financial support from their sponsors.... From this, the Squam Letter posits that there is a systemic risk posed by Money Funds. We see these numbers in a very different way. As of the beginning of 2008, there were 807 Money Funds in existence. Of these 807 Money Funds, 771 -- over 95% -- did not receive any financial support from their sponsors. Moreover, of these 807 Money Funds, 806 did not break a buck during the worst financial crisis since the Great Depression. In other words, roughly 99.9% of Money Funds did not break a buck during a financial crisis the likes of which most of us had never before seen. The Reserve Primary Fund, the only Money Fund to break a buck, was liquidated and it shareholders received back 99.2% of their money.... That is phenomenally good performance, during a period of near economic chaos."
He says, "The sudden collapse of Lehman Brothers and the weakness of a number of other large financial firms that were major issuers of commercial paper caused the problem in the money markets in September 2008 and caused the Reserve Primary Fund to break a buck. Money Funds did not cause the problems at the issuers or in the money markets, but instead experienced redemptions and credit quality concerns that reflected the problems at commercial paper issuers. Those concerns over the issuers of commercial paper led to illiquidity in the money markets in 2008, much as was the case in 1974 when Penn Central defaulted on its commercial paper obligations. Changing the capital structure of Money Funds would do nothing to address credit quality or liquidity issues among the issuers of commercial paper and the impact that problems at one or more major issuers can cause to the money markets as a whole. However, the focus in Title I of the Dodd Frank Act on improving the transparency, capital and liquidity standards of significant bank and nonbank financial firms that are major commercial paper issuers, and the actions that the regulators will take to implement those requirements, will have the beneficial effect of reducing risk and increasing stability in the money markets. Greater stability among the major issuers of commercial paper into the money markets will translate into lower risks at Money Funds."
Hawke also tells the SEC, "We note that an additional destabilizing factor, which has been largely overlooked in the discussion, was an increase in deposit insurance limits and a competing money management deposit product introduced suddenly by Congress and the FDIC in the midst of the crisis. On October 3, 2008, Congress temporarily increased deposit insurance coverage for all bank depositors to $250,000 (up from $100,000), and on October 13, 2008, the FDIC issued an unlimited federal insurance guarantee of bank deposits bearing an interest rate of 0.5% (a rate defined in the FDIC rules as "noninterest bearing," but that was actually a very competitive rate at the time for federally-insured money) or less."
Hawke writes, "The stable performance of Money Funds during the recent financial crisis is consistent with how stable Money Funds have been over the entire 40 years that there have been Money Funds. Since 1971, only two Money Funds have broken the buck -- the Reserve Primary Fund mentioned above, and the Community Bankers U.S. Government Fund, a small institutional fund.... Now let us compare that record with the solvency records of banks during the same period. Since 1971 over 2,800 banks have failed, and an additional 592 were kept afloat through federal bailouts, at a total cost to the federal government of over $164 billion. During the financial crisis, from January 2008 through February 18, 2010, 344 banks failed in the United States. Keep in mind that U.S. banks are policed by an army of 26,000 federal bank regulators."
He continues, "Yet, surprisingly, the Squam Letter proposes a 'solution' to the 'problem' at Money Funds in the form of an entirely new capital structure that looks like, well, the capital structure of banks.... This approach has not worked well at banks and there is no reason to believe it would work at Money Funds. First, the most immediate problem during the financial crisis, as in the start of the Great Depression, was not asset quality. It was liquidity. A few percentage points of junior capital does little or nothing to address liquidity problems. Instead, maintaining a short-term fixed income portfolio, which holds a large chunk of ready cash and near-cash assets and essentially self-liquidates in its entirety in a relatively short period of time, provides a much better protection against a "run." This is the approach taken by the SEC in Rule 2a-7, and these liquidity requirements have been made even more stringent through the 2010 amendments to that rule."
Finally, Hawke writes, "We also note that the capital structure proposed by the Squam Letter also bears a striking resemblance to the capital structures formerly used for asset securitization and structured finance vehicles.... Those vehicles failed dramatically during the recent financial crisis. It is not clear why the authors of the Squam Letter would resurrect that structure as a model for Money Funds, although we note that the complex securitization vehicle capital structure, like the one proposed here by the Squam Letter for Money Funds, was developed by academics and rating agencies. Finally, we note that the general thrust of the Squam Letter proposal is a variation on the theme of increased sponsor support of Money Funds as a means to reduce the investment concerns of risk-averse investors, a position that has been championed by one of the rating agencies. A major goal of financial reform is to reduce systemic risk. Tying the solvency of Money Funds to sponsor support for those funds as a means to reduce the concerns of risk-averse investors, is fundamentally the wrong direction to go in order to reduce systemic risk."
