The Investment Company Institute's Chief Economist Brian Reid posted yet another "Viewpoint," this one in response to comments yesterday from Federal Reserve Chairman Ben Bernanke on money market mutual funds' exposure to European credits. The update, entitled, "Bringing Money Market Funds' European Investments into Focus," says, "In his written testimony on Capitol Hill today, Federal Reserve Board Chairman Ben Bernanke created a fuzzy and incomplete picture of money market funds and their investments in European-headquartered financial institutions. Whether by intent or not, the Fed testimony left the impression -- magnified by media accounts -- that these funds have a unique and substantial vulnerability to any future turmoil in overseas markets."
Bernanke said to Congress yesterday, "To help calm dollar funding markets and support the flow of credit to U.S. households and businesses, the Federal Reserve acted in concert with major foreign central banks to enhance the U.S. dollar swap facilities that were originally put in place during the global financial crisis and reestablished in May 2010.... The expanded use of the swap lines has helped to ease funding pressures on European and other foreign banks, lower tensions in U.S. money markets (in which foreign banks are major participants), alleviate pressures on foreign banks to reduce their lending in the United States, and boost confidence at a time of considerable strain in international financial markets.... Notably, U.S. financial institutions have very limited direct net credit exposures to the most vulnerable euro-area countries, and U.S. money market funds also have almost no exposure to those countries."
He explained, "Although U.S. banks have limited exposure to peripheral European countries, their exposures to European banks and to the larger, "core" countries of Europe are more material. Moreover, European holdings represented 35 percent of the assets of prime U.S. money market funds in February, and these funds remain structurally vulnerable despite some constructive steps, such as improved liquidity requirements, taken since the recent financial crisis. U.S. financial firms and money market funds have had time to adjust their exposures and hedge their risks to some degree as the European situation has evolved, but the risks of contagion remain a concern for both these institutions and their supervisors and regulators. In particular, were the situation in Europe to take a severe turn for the worse, the U.S. financial sector likely would have to contend not only with problems stemming from its direct European exposures, but also with an array of broader market movements, including declines in global equity prices, increased credit costs, and reduced availability of funding."
ICI's Reid answers in his response, "The full picture: the majority of money market funds' European exposure is invested in banks that are integral players in the U.S. financial system -- including banks that are on the Fed system's own list of official counterparties. The fact that they're getting some of their financing from money market funds doesn't add risk to the U.S. financial system. What's unfortunate is that all the data that the Fed would need to provide a clearer picture are publicly available. We've been pointing out the exaggerations in coverage of this issue for the last nine months."
He explains, "The Fed chairman made headlines with his statement that investments in European banks made up 35 percent of the portfolios of U.S. prime money market funds in February. That's true. But while his testimony was careful to explain away the exposures that U.S. banks have to potential financial strains in Europe, it failed to provide any of the detail that would put money market funds' investments into similar context."
He continues, "First, it's important to note that European-based financial institutions that borrow in the short-term U.S. dollar market are typically large global banks with operations stretching well beyond Europe's borders -- including in the U.S. There's also the fact that Europe is a big continent, and the risks of the eurozone debt crisis aren't spread evenly. Bernanke correctly noted that "U.S. money market funds have almost no exposure" to "the most vulnerable euro-area countries. In fact, more than half of prime money market funds' European holdings are in banks headquartered in the United Kingdom, Sweden, and Switzerland -- all countries that don't use the euro for currency, and thus are outside the single-currency zone that's vulnerable to debt crises in Greece and other "peripheral" countries."
Reid tells us, "Money market funds' holdings in the eurozone amount to 15.5 percent of their portfolios, and virtually all of those holding are in banks headquartered in Europe's strongest economies -- France, Germany, and the Netherlands. To get the most accurate picture, it helps to drill down to the holdings in individual banks. We can do that because money market funds are the most transparent financial product in America, disclosing every holding in their portfolios to the public every month. Here's what we find: 52 percent of U.S. money market funds' holdings of European-based institutions are invested in securities of banks that have U.S. affiliates that serve as "primary dealers".... Among the instruments of these primary dealers that U.S. prime money market funds hold, half (51 percent) are repurchase agreements. Such repos are fully collateralized, usually with U.S. Treasury and government agency securities that these institutions hold precisely because they are primary dealers."
Finally, Reid adds, "When money market funds invest in European banks that aren't primary dealers, they tend to be institutions with significant U.S. operations, even if they're not household names. For example, Rabobank Nederland NV has both retail and corporate banking operations in the United States. Institutions like Barclays, Deutsche Bank, UBS, HSBC, and Credit Suisse are deeply embedded in the U.S. financial markets. The fact that money market funds buy their short-term debt does not create unique risks to the U.S. financial markets. In fact, as primary dealers, these European-headquartered banks would be heavy borrowers in the U.S. markets even if money market funds didn't exist. Congress and the public deserve a clear picture of financial risks, and the details do matter."
In similar news, Fitch Ratings released its latest portfolio holdings update entitled, "U.S. Money Fund Exposure and European Banks: A Partial Disengagement." It says, "U.S. prime money market fund (MMF) exposure trends continued to stabilize, as an equilibrium appears to be taking shape after the relatively large reductions in allocations to euro zone banks during second-half 2011.... MMF exposures to European banks as a whole declined by 4% on a dollar basis since end-January, while exposures to euro zone banks increased by 21%, driven by higher MMF allocations to French, German, and Dutch banks.... MMF exposures to euro zone banks have increased in each of the last two months but remain more than 60% below end-May 2011 levels."
