The GAO, or Government Accountability Office, published a "Report to Congressional Committees on Money Market Mutual Funds yesterday. Subtitled, "Pandemic Revealed Unresolved Vulnerabilities," its summary explains, "In 2010 and 2014, the Securities and Exchange Commission (SEC) revised its money market mutual fund (MMF) rules after some MMFs experienced runs (heavy redemptions) during the 2007–2009 financial crisis. For example, SEC required MMFs to hold minimum levels of liquid assets that they could sell to meet redemptions. If these liquidity levels fell below the minimum, SEC allowed certain MMFs to charge investors a liquidity fee for redeeming shares or to impose a redemption gate to temporarily suspend redemptions."
The report continues, "Evidence indicates that SEC's reforms did not prevent runs during the COVID-19 pandemic. For example, prime MMFs -- which can invest in all types of short-term debt instruments -- held by institutional investors experienced net redemptions of about 30 percent of their total assets in a 2-week period in March 2020. Some evidence also indicates SEC's reforms may have contributed to the runs. Some investors may have preemptively redeemed MMF shares to avoid incurring a liquidity fee or losing access to their funds under a redemption gate. To stabilize the financial system during the pandemic, the federal government created lending and liquidity programs, including one to help support prime and tax-exempt MMFs."
The GAO comments, "In February 2022, SEC proposed a rule intended to reduce run risk by removing fees and gates, increasing minimum liquidity requirements, and adopting a new method to price certain MMF shares. Industry, academic, and other stakeholders generally support removing the link between gates and fees and minimum liquid asset levels and increasing minimum liquidity requirements. Moreover, a few stakeholders maintain that the proposed new pricing method could reduce run risk, but stakeholders generally have raised concerns about the method's complexity and cost. Consistent with its guidance, SEC staff conducted economic analyses to support the proposed rulemaking. The analyses were largely qualitative because SEC does not have data to quantify most of the proposed rule's benefits and costs. As part of the rulemaking, SEC has proposed amending an MMF reporting form, which could provide it with additional data to monitor run risk at MMFs. SEC currently plans to complete the rulemaking in April 2023."
A sidebar entitled, "Why GAO Did This Study," states, "The COVID-19 pandemic highlighted the ongoing vulnerability of certain MMFs to runs. Currently holding around $5 trillion in assets, MMFs act as intermediaries between investors seeking liquid, safe investments and corporate and government entities that issue short-term debt. If investors perceive a risk that their MMFs will suffer losses, they have an incentive to be the first to redeem their shares. A run on MMFs can spread to other entities and financial markets because MMFs are interconnected to financial firms, the financial system, and the economy."
It says, "The CARES Act and the American Rescue Plan Act included provisions for GAO to monitor the federal government's efforts to respond to the COVID-19 pandemic. This report reviews (1) SEC's reforms designed to reduce run risk at MMFs exposed by the 2007–2009 financial crisis, (2) available evidence on the effectiveness of MMF reforms in reducing run risk during the pandemic, and (3) current actions SEC is taking to reduce run risk at MMFs."
The sidebar adds, "GAO reviewed studies and reports by federal agencies and other stakeholders about the vulnerability of MMFs to runs, analyzed MMF data on changes in fund assets, and reviewed SEC rule releases and related materials. GAO also interviewed officials from SEC and other federal agencies, three industry associations, and three MMFs."
The report says, "Like the 2007–2009 financial crisis, the COVID-19 pandemic exposed the vulnerability of certain money market mutual funds (MMF) to large and unexpected redemptions by investors (called runs). Holding around $5 trillion in assets at the end of November 2022, MMFs buy securities that underlie the short-term funding markets -- such as short-term U.S. Treasury securities, short-term municipal securities, and commercial paper -- which help support the broader financial markets and economy. The types of MMFs that were vulnerable to runs -- prime and tax-exempt MMFs as described below -- hold around $1 trillion in assets. During periods of market stress, MMF shareholders may be motivated to redeem shares to avoid potential losses or redemption-related costs. If MMFs sell securities at reduced prices to meet such redemptions, the sales can contribute to stress in the underlying short-term funding markets and affect the ability of financial and nonfinancial firms to raise capital in such markets."
It continues, "In response to market disruptions caused by the COVID-19 pandemic, the Board of Governors of the Federal Reserve System (Federal Reserve) created an MMF liquidity facility in March 2020, similar to the actions it took during the 2007–2009 financial crisis. The liquidity facility helped MMFs meet investor redemptions, which enhanced the functioning of the short-term funding markets and provision of credit to the broader economy. The facility ceased extending credit in March 2021. Although the facility and other actions helped stabilize the markets, some stakeholders have raised concerns that the Federal Reserve's repeated MMF interventions could increase moral hazard and systemic risk."
The GAO report summarizes, "After the 2007–2009 financial crisis, the Securities and Exchange Commission (SEC) enacted a series of reforms designed to make MMFs more resilient and less vulnerable to runs. For example, in 2014, SEC issued regulations to enable certain MMFs to mitigate runs by giving them the discretion to impose a liquidity fee or to suspend redemptions temporarily if a fund's liquidity level falls below a specified threshold. In light of the MMF runs during the recent pandemic, SEC proposed in February 2022 MMF reforms that would remove or revise some of the prior reforms and add new requirements designed to help prevent runs and improve the resilience and transparency of MMFs."
It also says, "[W]e reviewed reports, rulemakings, and other pertinent materials issued by SEC, the President's Working Group on Financial Markets, the Financial Stability Oversight Council, and other federal agencies that analyzed the MMF runs that occurred in September 2008 or March 2020. To examine available evidence about the effect of SEC's MMF reforms on the March 2020 runs, we conducted a literature review to identify relevant journal articles, working papers, and other studies published from March 2020 onward. Specifically, we conducted key-word searches of scholarly, legal, and other databases, including Fed in Print, Dialog, ProQuest, Social Science Research Network, and Westlaw Edge. We identified 11 articles relevant to our research objective. To assess the methodological quality of the selected studies, we obtained information about each study and about the features of the evaluation methodology."
The report tells us, "In addition, we used data from the Office of Financial Research's U.S. Money Market Fund Monitor and the Investment Company Institute to analyze changes in MMF assets during the financial crisis and the onset of the pandemic. We assessed the reliability of these data by (1) performing electronic testing, (2) reviewing existing information about the data and the system that produced them, and (3) interviewing agency officials knowledgeable about the data. We determined that the data were sufficiently reliable for analyzing changes in MMF assets for certain periods."
It adds, "For the third objective, we reviewed SEC's proposed MMF rule, documentation SEC staff prepared about the proposed rule for the Financial Stability Oversight Council, and relevant federal agency, academic, and industry studies on MMFs. We reviewed SEC's guidance on economic analysis for rulemakings and evaluated whether SEC staff followed the guidance in conducting economic analysis for the proposed MMF rule. We also analyzed public comment letters on the proposed rule. We reviewed SEC forms that MMFs use to report information to SEC and evaluated SEC's procedures for analyzing and reporting on the information. Finally, we interviewed three industry associations (Investment Company Institute, Securities Industry and Financial Markets Association, and Better Markets) and three MMFs, which we judgmentally selected based on their involvement in the comment process and expertise. The views of the selected associations and MMFs are not generalizable and, thus, do not necessarily reflect the views of all stakeholders commenting on the proposed rule."
Finally, the GAO writes, "For all three objectives, we interviewed staff of other Financial Stability Oversight Council members -- including the Department of the Treasury, Federal Reserve, Commodity Futures Trading Commission, Office of the Comptroller of the Currency, and Federal Deposit Insurance Corporation -- about MMFs, including their risks and regulation. We conducted this performance audit from November 2021 to February 2023 in accordance with generally accepted government auditing standards. Those standards require that we plan and perform the audit to obtain sufficient, appropriate evidence to provide a reasonable basis for our findings and conclusions based on our audit objectives. We believe that the evidence obtained provides a reasonable basis for our findings and conclusions based on our audit objectives."
