In early February, a release announced the "SEC Requests Comment on Potential Money Market Fund Reform Options Highlighted in President's Working Group Report." (See our Feb. 4 Link of the Day.) While interested parties have until the April 12 deadline to submit thoughts, the first real comment was posted by Jeffrey Gordon, a Professor at Columbia Law School. Gordon writes, "This letter is submitted by me personally in connection with the request for comments by the Securities Exchange Commission in response to its Request for Comments on Potential Money Market Fund Reform Measures in the President's Working Group Report of December 2010. I am the Richard Paul Richman Professor at Columbia Law School and co-director of the Millstein Center for Global Markets and Corporate Ownership. I participated extensively in two prior rounds of MMF reform proposals, including the rule-making that resulted in the present rules, commented on FSOC's proposed recommendations in 2102, and published an article that addresses MMF reform generally, 'Money Market Funds Run Risk: Will Floating Net Asset Value Fix the Problem?' (with Christopher M. Gandia). The conclusion of the article was that 'the best empirical evidence we have suggests that floating NAV will not reduce MMF run-risk during periods of financial distress.'" (See the comment letters to the SEC here.)
He explains, "My final submission was a November 17, 2013, comment letter (attached hereto), arguing that neither floating NAV nor gates and fees would provide stability to MMFs at a time of financial stress, indeed, could exacerbate run pressure. Some of my observations in that November 2013 comment letter are particularly pertinent to this round of reform deliberation and I would like to enter them into the record."
Gordon's previous comment letter says, "In candor I think the SEC has produced flawed proposals that simply fail to appreciate the nature of the MMF product and the sources of systemic risk. MMFs are a kind of nonbank bank; they take credit risk, provide liquidity transformation, and yet under current SEC rules, have no capacity to absorb losses. The floating NAV proposal makes this painfully clear. If any portfolio security were to default, ever, there is no virtually no way that the fund could report par, $1 per share, unless the sponsor agreed to swap out the defaulted security. This is because MMFs are flow-through vehicles. Dividends on portfolio securities may not be retained and thus are not available to apply against losses."
It continues, "An obvious point of stability of a bank or a bank substitute is capital, which provides the capacity to bear loss. Indeed, a major thrust of post-financial crisis reform has been to require financial institutions to hold more capital. In the case of MMFs, the SEC has proceeded as if unaware of this consensus. The SEC proposal is filled with new disclosure requirements for MMFs, because this is the SEC's hammer. Experts on financial institutions make the point, however, that the stability of an entity engaged in liquidity transformation depends upon its assets being informationally insensitive -- that as soon as depositors need to begin evaluating the credit risk of the bank's portfolio, run risk escalates. Detailed current disclosure, which will lead to competitive valuation estimates of portfolio assets and the search for arbitrage opportunities, may well be a source of instability in a financial crisis for MMFs with no capacity to absorb loss."
Gordon asks, "What is the consequence? Ultimately the stability of MMFs depends upon implicit guarantees and other support by their sponsors, and, in extremis, the willingness of the Federal Reserve to take credit risk to avoid a massive run among MMFs. Nothing in the SEC rulebook tests sponsor capacity to provide support, nor links sponsor capacity to fund size, nor requires disclosure about sponsor capacity, much less requires any sponsor support. To be blunt, the SEC proposal relies on a future Federal Reserve bailout to protect the stability of the MMF sector."
He continues, "The SEC has been sensitive to encroachments by the Federal Reserve Board on its securities markets domain. It seems to me that the best way for the SEC to proceed is to recognize that it needs to build in some mechanism for loss absorbency into its MMF regime. I think that both Proposals Two and Three of the FSOC's Proposed [previous] Recommendations on MMF Reform are useful starting points. I myself have previously offered a proposal for a 'bundled' Class A/Class B share structure that would lead users, especially institutional users, to internalize the loss-absorbency and run-risk mitigation features that are necessary elements of reform. That proposal is more fully described in a comment letter of August 12, 2011."
Gordon tells us, "Notice what this proposal accomplishes: it requires the users of institutional money market funds to supply the capital necessary for their stability and it creates disincentives for such investors to 'run.' These are advantages over proposals that contemplate sale of Class B shares to a separate group of capital suppliers. In particular, the 'unit' concept means that an investor who 'ran' by redeeming Class A shares at par at a time of falling asset values could not thereby impose losses on non-redeeming investors. The losses would be borne by the matched Class B shares, including shares held by the 'running' investor, which cannot be disposed of except after a month's lag."
He writes, "The unit concept therefore provides an additional element of systemic stability beyond proposals that call for a capital cushion only. A capital cushion cannot, by itself, fully protect against runs. Even if the capital could absorb the loss of the largest portfolio position, another default could break through the Class B. Thus in periods of financial instability, runs remain a threat despite first loss protection, because the run strategy presents no downside for the individual running investor. A Class A/Class B unit changes the dynamic. Default risk, especially risk of multiple defaults that break through the Class B, is fact low. By contrast, given a run, the chance of fire sale losses is much higher. A holder of matching Class B shares now sees downside in the decision to run, with a much greater probability of loss because of the run itself. For an even more powerful anti-run incentive, the Class B shares of the running shareholder could be subordinated to the Class B shares of the non-running shareholders. The combination of the capital layer and the unit approach should significantly increase money market fund stability."
Gordon also states, "There is perhaps $6 trillion in short term funds in the global financial system looking for safety and liquidity outside of the banking system. It is important to devise financial institutions that can manage such cash flows in a systemically robust way and that does not depend on a taxpayer subsidy for its rescue. The prior design of MMF was an experiment that produced a bad outcome. So we must experiment again, learning from experience and being willing to revise our institutions in light of new economic challenges."
Finally, he adds, "I hope to comment more particularly on the PWG report before the comment deadline. One thing that I think the Commission should not ignore is the distortionary impact of its current MMF Rule on financing decisions of the Federal Home Loan Banks. As documented in the PWG report, Chart 1, p.9 the enacted Reforms resulted in a dramatic increase in the demand for Government funds (because they qualified for fixed NAV), and a decrease in the demand for Prime funds (floating NAV). The demand for short term USG issuances has been fulfilled by a significant increase in short term issuances by the Federal Home Loan Bank System. In formulating a reform proposal to address the problems revealed by the Covid-crisis run in March 2020, the Commission should consider the financial stability and other effects associated with this shift in Federal Home Loan Bank finance."
In other news, Crane Data published its latest Weekly Money Fund Portfolio Holdings statistics Tuesday, which track a shifting subset of our monthly Portfolio Holdings collection. The most recent cut (with data as of Feb. 26, 2021) includes Holdings information from 71 money funds (down 2 funds from a week ago), which represent $2.082 trillion (down from $2.170 trillion) of the $4.757 trillion (43.8%) in total money fund assets tracked by Crane Data. (Our Weekly MFPH are e-mail only and aren't available on the website.)
Our latest Weekly MFPH Composition summary again shows Government assets dominating the holdings list with Treasury totaling $1.082 trillion (down from $1.143 trillion a week ago), or 52.0%, Repurchase Agreements (Repo) totaling $532.8 billion (up from $504.5 billion a week ago), or 25.6% and Government Agency securities totaling $261.6 billion (down from $269.4 billion), or 12.6%. Commercial Paper (CP) totaled $73.1 billion (down from $93.5 billion), or 3.5%. Certificates of Deposit (CDs) totaled $53.1 billion (down from $57.4 billion), or 2.5%. The Other category accounted for $53.5 billion or 2.6%, while VRDNs accounted for $25.6 billion, or 1.2%.
The Ten Largest Issuers in our Weekly Holdings product include: the US Treasury with $1.086 trillion (52.2% of total holdings), Federal Home Loan Bank with $138.2B (3.2%), Fixed Income Clearing Corp with $67.1B (3.2%), BNP Paribas with $58.2B (2.8%), Federal Farm Credit Bank with $52.0B (2.5%), RBC with $44.9B (2.2%), Federal National Mortgage Association with $44.2B (2.1%), JP Morgan with $37.5B (1.8%), Barclays PLC with $35.4B (1.7%) and Credit Agricole with $30.9B (1.5%).
The Ten Largest Funds tracked in our latest Weekly include: JPMorgan US Govt MM ($224.1 billion), Wells Fargo Govt MM ($143.6B), BlackRock Lq FedFund ($143.3B), Fidelity Inv MM: Govt Port ($136.0B), Morgan Stanley Inst Liq Govt ($113.4B), BlackRock Lq T-Fund ($111.5B), Dreyfus Govt Cash Mgmt ($95.1B), JP Morgan 100% US Treas MMkt ($93.4B), First American Govt Oblg ($80.4B) and JP Morgan Prime MM ($74.2B). (Let us know if you'd like to see our latest domestic U.S. and/or "offshore" Weekly Portfolio Holdings collection and summary, or our Bond Fund Portfolio Holdings data series.)
