On Friday morning's Federated Investors quarterly earnings conference call, President & CEO Chris Donahue added a segment to the normal presentation that addressed "myths" surrounding the debate over money fund reform. Entitled, "Money-market fund regulation comments of J. Christopher Donahue," it says, "During the last few quarters' conference calls I have made comments and answered questions concerning potential SEC proposals for the further regulation of money market funds. I discussed Federated's belief that money funds were meaningfully and sufficiently strengthened by the extensive regulatory revisions to Rule 2a-7 in 2010 and that these enhancements were tested and worked successfully through a series of challenges in 2011 that included the United States debt ceiling crisis and credit downgrade as well as worries over a Greek default and European bank solvency. You know well our position opposing the SEC's draconian proposals for floating the NAV and/or instituting redemption restrictions and capital requirements. We are among a broad group of businesses, state/local government agencies, trade associations, public interest groups and financial institutions that believe these rules will destroy the functionality, utility, effectiveness and the very essence of money market funds, which are so vital to our economy."
Donahue continues, "I want to take a few minutes on this call to take a look at on some of the myths that continue to be spread by regulators and simply repeated by many in the media. The first one we continually hear is that money market funds were either at the center of or significantly exacerbated the financial crisis of 2007-2008. This is not true. If one accepts this falsehood, then the arguments in favor of preserving the utility of money funds for 50 million investors and the multitude of municipalities, corporations and other entities who depend on money funds for efficient funding can be ignored."
He explains, "The facts tell a very different story. The meltdown occurred because certain financial institutions placed enormous leveraged bets on the subprime housing market amplified in many cases by derivatives and by the Fed's easy money policy. When those bets went bad, the complex web of counterparty arrangements between different institutions threatened to cause a general collapse of the system. Importantly, only one money market fund lost its $1 NAV in September 2008 -- and only after an 18-month period that saw the failure of dozens of banks, mortgage lenders and other financial institutions causing the credit markets to freeze up."
Donahue tells us, "This is often paired with the falsehood that money market funds are "susceptible to runs" and were bailed out by taxpayers. The Reserve Primary Fund failure in September 2008, followed an unprecedented period that saw the collapse of Lehman Brothers, a number of major financial institutions on the brink and inconsistent responses to these events by the government. As counterparty risk perception increased, institutional investors redeemed 15 percent of their prime money fund shares, followed by large inflows into money funds backed by government debt. For every dollar that left prime funds, 63 cents flowed into government money market funds. The conclusion that should be drawn from this is that investors were not fleeing money market funds but rather were reallocating assets to the most conservative investments in a reeling market beset by the failures and near failures of many leading financial institutions, unpredictable government policies and widespread concerns about whether prime funds could continue to sell assets into the frozen commercial paper market."
He adds, "The steps then taken by the Fed and Treasury were not a "bailout" of money funds but rather, in the case of the Fed actions, necessary and proper steps to restore liquidity to the financial system as a whole. It is important to remember that when the dust settled, the Reserve Primary Fund investors lost less than a penny on the dollar and no taxpayer funds were needed. In fact, money market fund companies paid $1.2 billion to the U.S. Treasury for insurance that was never used. This is a remarkable contrast to the costs of the bailouts of 2,840 failed banks and an additional 592 banks that required 'assistance transactions' at a total cost of $188.5 billion from 1971 through 2010."
Donahue continues, "Today money funds hold 30 percent or more of assets in 7-day available cash and 10 percent in overnight available cash. Money funds are now required by the SEC to have more than double the amount of cash on hand that was needed in September 2008 to pay redeeming shareholders."
He says, "Another tall tale that is being bandied about concerns the perceived evils of Europe and the view that a significant source of credit risk in money market funds over the past year has been the large exposure to global banks headquartered in Europe. One official even suggested that money market funds could somehow be a conduit for smuggling any unexpected economic problems on the Continent back into the US. Here again the facts paint a much different picture. The majority 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." Primary dealers are financial institutions designated by the Federal Reserve Bank of New York to serve as trading counterparties in the Fed's implementation of monetary policy. These dealers are required to participate every time the U.S. Treasury auctions its securities. They are central players in the U.S. financial system."
Donahue also says, "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. 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. Total prime money market funds' holdings in the eurozone amount to 15.5 percent of their portfolios, and virtually all of those holding are in large banks with global diversified operations headquartered in Europe's strongest economies -- France, Germany, and the Netherlands."
He continues, "One of my favorite of the fairy tales is the misplaced concern that investors believe that money market funds are guaranteed and there is confusion with banks or checking accounts. Nowhere in any money market fund prospectus or marketing materials is there anything that would convey that money invested is guaranteed. In fact the risks are clearly and repeatedly noted in bold print -- Not FDIC insured -- May Lose Value -- No Bank Guarantee. Institutions hold more than 60 percent of the $2.6 trillion invested in money market funds and these professionals certainly know the difference between a fund and a bank account. The loss experienced by Reserve fund shareholders clearly demonstrated the non-insured status of money market funds. Further a recent survey by Fidelity Investments shows the vast majority of retail investors also knew that money market funds are investments and not guaranteed."
Donahue adds, "Lastly, in promoting the devastating idea of a floating NAV, some folks have been putting forth the fanciful notion that the $1 NAV, the hallmark of money market funds, is somehow made up or illusory. Far from it. Money fund shares price at a dollar on a daily basis, not because they have promised to repay shares at a dollar, but because the underlying assets are required to meet very stringent credit quality, liquidity and maturity requirements under current SEC regulations. And those regulations were strengthened in 2010 by the SEC based on recommendations from money fund providers."
Finally, he says, "The ability to transact at the $1 NAV provides a real benefit to corporations, government entities and other money fund users by allowing them to use automated cash management processes, facilitating same day transaction processing, shortening settlement cycles, and reducing float balances and counterparty risk. These are measurable benefits that translate directly into lower costs of capital and higher returns on assets. With so much at stake for the tens of millions of individual investors, corporations, government entities and non-profits who depend on money market funds for cash management and raising funds, it is important to set the record straight."
