U.S. Securities and Exchange Commission Chairman Mary Schapiro spoke Thursday night at the Society of American Business Editors and Writers (SABEW) Annual Convention in Indianapolis, and featured money market mutual funds as one of her major topics. She said, "The second memory that I want to refresh arises from the more recent financial crisis. In September 2008, the Reserve Primary Fund held just over 1 percent of its assets in commercial paper issued by Lehman Brothers. When Lehman declared bankruptcy, the fund took a hit and declared that it could not return to investors the full dollar per share that they had put in. This phenomenon -- known as "breaking the buck" -- triggered a run on the fund and, in short order, a run on other money market funds as well."
Schapiro explained, "This happened, in part, because most investors treat money market mutual funds like bank accounts -- where customers are guaranteed to get at least one dollar back for every dollar they deposit. However, these products are, in fact, not bank accounts, but investment vehicles whose value can on occasion slip below or move above a dollar. Following Lehman's bankruptcy, investors redeemed $40 billion, or roughly two-thirds of the Reserve Fund's total value, in just two days. And, then the fear began to spread."
She said, "Within the week, investors had withdrawn $310 billion from prime money market funds -- 14 percent of those funds' total assets, with some firms hit much harder than others. This helped freeze short term credit markets, resulting in the loss of short-term financing that businesses and institutions needed for operations. The run stopped, but only after the government stepped in with a taxpayer-funded Treasury guarantee that reassured investors and calmed the market -- and that also left the American taxpayer implicitly on the hook for $3 trillion in money market fund shares."
Schapiro continued, "That event vividly underscored the need to tighten liquidity and risk requirements. And so the SEC, in 2010, adopted new rules that for the first time imposed robust liquidity requirements on money market funds. The reforms also required higher-quality credit, shorter maturity limits, and periodic stress tests, making money market fund portfolios stronger and more resilient. But, when we passed these reforms, I clearly stated that we needed to do more -- that those reforms were just a first step. Because, despite changes in the assets they hold, money market funds remain susceptible to a sudden deterioration in quality of holdings and consequently, remain susceptible to runs."
She told the audience of business writers, "The companies that manage money market funds often go to great lengths to avoid breaking the buck. They have been quick to infuse their own capital to prop up the value of money market funds, and over the past two years they have waived investor fees in order to prevent fund values from falling below $1.00. SEC staff provided no-action assurances that allowed more than 100 money market funds to enter into capital support agreements with their parent companies in 2007-2008. Without these capital infusions and other support, these funds might have broken the buck, kicking off other destabilizing runs. These numbers underscore the fact that the Reserve Primary Fund's collapse should not automatically be regarded as an isolated incident."
Schapiro added, "Because Congress eliminated the possibility of another Treasury guarantee, there would be little regulators could do to manage or stop such a run. Indeed, money market funds remain particularly vulnerable to exogenous shocks, like a sovereign debt crisis in the Euro zone or a natural disaster across the globe. A 2010 Moody's study identified nine financial incidents that kicked off multiple sponsor interventions in the U.S. and Europe, not including the financial crisis. These range from the Orange County default in the mid-90s to the collapse of individual insurance companies, to the California energy crisis of the early 2000's. In addition, as recently as November 2011, the sponsor of some money market funds bought out securities of a Norwegian bank that was downgraded to non-investment grade status."
She said, "Whenever there is an unexpected shock to the financial system, or a natural disaster with market moving implications, the staff knows that the first thing I will ask is: "what is the related money market fund exposure?" Money market fund investors are historically very risk averse and are motivated to pull their money -- and get their dollar -- in advance of any deterioration of value. To avoid the likelihood of another money market fund run, there are two serious options I am hoping that the SEC will propose: either float the net asset value, so that a money market fund's value goes up and down like any other mutual fund, or impose capital requirements, combined with limitations or fees on redemptions."
Finally, Schapiro commented, "These proposals are designed to, respectively, desensitize investors to the occasional drop in value or make it less likely that the funds will not be able to absorb a loss and cause a run. In the post-mortem of the financial crisis many have argued that regulators sat silent on the sidelines rather than raising alarm bells. As a regulator who saw the damaging effects of the 2008 run on money market funds, I find it hard to remain on the sidelines despite calls to declare victory on this issue. While many say our 2010 reforms did the trick -- and no more reform is needed -- I disagree. The fact is that those reforms have not addressed the structural flaws in the product. Investors still have incentives to run from money market funds at the first sign of a problem."
