The U.S. Treasury's Office of Financial Research released its "2016 Annual Report to Congress" and "2016 Financial Stability Report yesterday, saying that "overall risks to U.S. financial stability remain in a medium range. The reports, which contain a number of references to money market mutual funds, mutual funds, repurchase agreements and "shadow banking," explain, "A fundamental element of the OFR mission is to improve financial data to support the Financial Stability Oversight Council (FSOC) and promote financial stability.... At the OFR, we have taken a particular interest in data related to shadow banking. Bank-like activities that take place outside the banking industry often face less oversight and transparency. Since the crisis, the OFR and financial regulators have gained more access to detailed information about shadow banking activities that were largely opaque a decade ago, including data on hedge funds, money market funds, and securities financing transactions."
The OFR's Annual Report explains, "Projects are underway to expand the scope of information about shadow banking. The OFR is planning permanent data collections on repurchase agreements and securities lending -- important sources of short-term funding in the financial industry.... Funding and liquidity risks persist in the U.S. financial system. These types of risk are slow to change."
It tells us, "Liabilities that are payable on demand and not backed by government backstops are susceptible to run risk. The volume of "runnable" liabilities has decreased since the crisis when they were hit by runs and fire sales. Such liabilities include repurchase agreements, securities loans, commercial paper, money market funds, and uninsured bank deposits. Post-crisis reforms partly account for the decrease (see Figure 15). The sharp increase in 2013 coincides with the end of temporary unlimited deposit insurance under the Dodd-Frank Act."
OFR comments on "Shadow Banking," writing, "We define shadow banking as the extension of credit by nonbank companies, or credit funded by liabilities susceptible to runs because they are payable on demand and lack a government backstop.... Runs on prime money market funds accelerated the financial crisis in September 2008 after the Reserve Primary Fund "broke the buck," falling below a net asset value of $1 per share by more than half a cent. To curb this risk, a recent SEC rule requires prime and tax-exempt money market funds with institutional investors to let their net asset values float with the value of underlying assets. Prime and tax-exempt funds with retail investors may continue to offer a stable net asset value; they may be sold and redeemed at $1 per share but must report the market value of their share prices."
They continue, "Under the rule, both types of funds must adopt restrictions on redemptions and impose "liquidity fees," fees on redemptions that may rise as a fund's liquidity falls below certain levels. However, each fund's board has the power to suspend these requirements. In anticipation of this rule, which took effect on Oct. 14, 2016, $1 trillion shifted from prime funds to government funds (see Figure 20). Other funds and pools, some of which report a stable net asset value and have no government backstop, can also be vulnerable to run risk. These vehicles include some short-term investment funds sponsored by banks, local government investment pools, and private liquidity funds."
The report adds, "The OFR recently obtained data that the Office of the Comptroller of the Currency collects from national banks about their short-term investment funds. We also have data that the SEC collects from private liquidity funds. Combined, private liquidity funds and short-term investment funds had more than $500 billion under management at the end of June 2016, according to these data. State-regulated banks and local government investment pools do not report this information."
The OFR also comments, "In late July 2016, we launched our interactive U.S. Money Market Fund Monitor. The monitor converts data from the SEC's Form N-MFP into a user-friendly format on the OFR website. Users are able to examine individual funds and the industry as a whole on the basis of credit, interest rate, and liquidity risks. The monitor also helps the OFR and other users understand industry trends and activities in new ways. The monitor analyzes each risk category based on portfolio statistics and holdings."
The OFR's "Financial Stability Report" also comments on money funds, saying, "Runs on prime money market funds in September 2008 made the financial crisis more severe. A recent SEC rule addresses this risk. The rule requires prime and tax-exempt money market funds with institutional investors to let their net asset values float with the value of the assets they hold. Prime and tax-exempt funds with retail investors may continue to offer a stable net asset value -- that is, these funds may be sold and redeemed at a $1 share price. Even then, these funds will have to report the market value of their share prices."
Like the Annual Report, the Stability Report tells us, "Similar short-term investment vehicles can be subject to runs. Some of these vehicles report a stable net asset value, although they take credit risks and have no government backstop. These include retail prime and tax-exempt money market funds, some short-term investment funds sponsored by banks, some local government investment pools, and some private liquidity funds. Data are relatively new for some of these vehicles, so not all are included in the series.... An OFR paper last year used the SEC's Form PF to analyze private liquidity funds.... The form is comparable to Form N-MFP, allowing comparisons to money market funds."
Finally, the OFR adds, "European holdings of U.S.-based money market funds could also be vulnerable to a shock. The possible exit of a European state from the EU could create uncertainty about a fund's holdings of short-term debt issued by banks and corporations in that state. Using the OFR's U.S. Money Market Fund Monitor, the OFR assessed exposures of U.S. money market funds to large EU banks. Fund exposures to these banks have declined by half over the past five years but remain large for some banks (see Figure 27). An EU disruption that makes European assets less creditworthy could stress these funds. However, the effect on U.S. money market funds may be limited. In anticipation of the October deadline for compliance with money market fund reform, some substantially reduced the duration of their overall credit exposures, resulting in less volatile asset pricing."
