The Federal Reserve Bank of New York's Liberty Street Economics blog published a brief entitled, "From the Vault: Funds, Flight, and Financial Stability." Written by Anna Snider, it says, "The money market industry is in the midst of significant change. With the implementation this month of new Securities and Exchange Commission rules designed to make money market funds (MMFs) more resilient to stress, institutional prime and tax-exempt funds must report more accurate prices reflecting the net asset value (NAV) of shares based on market prices for the funds' asset holdings, rather than promising [sic] a fixed NAV of $1 per share." We review this below and we also debunk a recent article claiming that some Prime Inst MMFs have traded below $1.0000. (This is not the case.)
The blog explains, "The rules also permit prime funds, which invest in a mixture of corporate debt, certificates of deposit, and repurchase agreements, to impose fees or set limits on investors who redeem shares when market conditions sharply deteriorate. (Funds investing in government securities, which are more stable, are not subject to the new rules.) These changes, driven by a run on MMFs at the height of the financial crisis, add to earlier risk-limiting rules on portfolio holdings."
It tells us, "In what is being described as a "big sort," institutional MMF investors are rethinking their strategies for where to place large pools of cash; many are shifting investments from prime funds to funds that invest only in government securities, while others remain in place or undecided about their next move. Meanwhile, critics continue to debate whether the new rules go far enough, or perhaps too far. For readers interested in learning more, numerous posts in the Liberty Street Economics archive help illuminate the issues underlying the reforms." [Note: For the record, the article references a Seeking Alpha piece entitled, "The Big Sort", but Crane Data was the first to coin the term. See our Jan. 15 News, "The Big Sort: Who's Going Retail or Floating Inst Among Prime MMFs?."]
The NY Fed blog continues, "In "Money Market Funds and Systemic Risk," our bloggers examine the vulnerability of MMFs, and show why, in theory, a floating NAV could stanch runs. As they explain, the end of "NAV rounding" (MMFs traditionally rounded their shares to $1 per unit even if the market NAV was only within a half penny of $1) would temper investors' rush to redeem shares before others do when a fund suffers a loss, since there would be no more opportunity for arbitrage between the stable share price and the true value of the MMF share."
It adds, "Elsewhere on the blog, our authors looked at the extent to which sponsor support has been vital to maintaining MMFs' price stability. Their analysis, using information collected by regulators, showed that while the catalyst for the September 2008 run on MMFs -- the Reserve Primary Fund -- was the only fund to officially "break the buck" during the crisis, at least twenty-eight other funds would have also done so had their sponsors not provided crucial support in the form of cash infusions and purchases of the funds' securities at above-market prices. The bloggers called for reforms "that would provide a form of stability to the MMF industry not predicated on voluntary and uncertain support from sponsors.""
Liberty Street writes, "Our bloggers also explored MMFs' significance as a potential source of systemic risk, particularly through MMFs' increasing importance as a funding source for banks in recent decades. A check of the data at the end of 2012 revealed that MMFs held 43 percent of financial commercial paper, 29 percent of certificates of deposit, and 33 percent of repo agreements, prompting consideration of possible spillovers if MMFs reacted to run-like redemptions by fire-selling the bank assets in their portfolios."
Finally, the piece says, "Other blog analysis paid close attention to MMF investor movements during unsettling periods, such as the large outflows from prime funds that were exposed to the U.S. debt-ceiling and European debt crises in 2011, and weighed the pros and cons of fees and gates to reduce the run risk posed by investor redemptions."
In other news, an article in Institutional Investor, "New Money Market Rules Roil Investors," incorrectly claims that a Prime fund has dropped below $1.0000. While there are 2 Prime Inst funds showing NAVs at $0.9999, these currently have no investor assets. Every Prime Inst fund with investor money has traded at $1.0000 or higher every day since the conversion on October 14.
