News Archives: February, 2011

Below, we continue excerpting from our recent profile of BlackRock, which appeared in the February issue of our Money Fund Intelligence newsletter.... Q: How about recent customer concerns? What kind of questions are you getting? Mendelson says, "On the shadow NAV front, we've prepared a paper and recently hosted a webinar. We have material for our clients, and frankly the questions have been modest. There hasn't been a lot of client focus on it. This may change after their publication, but so far it has been pretty quiet."

Hoerner adds, "On Europe and municipal securities, we really haven't heard much. We did get some questions back in the late spring and early summer on the first go around. I think our clients are very comfortable with our credit process and with our philosophy in managing the funds. There is a comfort level I believe that our clients have with our funds."

Q: In general, what is your outlook for the Fed and rates? Hoerner tells us, "We're in uncharted territory here. We've never been in a situation where the Fed is implementing large amounts of quantitative easing. It's really hard to have a view with high level of confidence on how this is going to play out and the timing of it.... Money funds seem to be shortening up a bit in their weighted average maturities (WAMs). I think part of that is reflective of uncertainty over the future course of rates. Another part of it is the new liquidity requirements and the other changes to 2a-7. The key for money fund managers, and certainly what we're doing, is trying to maintain maximum flexibility."

Q: Are there factors that could push repo down to 10 basis points instead of 20 bps? Hoerner answers, "One potential action that could result in a lower Fed funds rate is the FDIC changing how they calculate their insurance assessment, moving from assessing it on deposits to assessing it on assets of the bank. The way it's proposed right now, banks would have to pay FDIC premiums on the reserves that they hold at the Fed. That might change, but if that holds, then a bank, instead of earning 25 at the Fed but having to pay, say 14 basis points for the FDIC premiums on that, they may be able to take that money from the Fed and sell into the Fed funds market. This would drive down the Fed funds rate. But the rules aren't finalized and it's not certain that will be the case."

Q: Will you have to be a giant in the future to manage money funds? Mendelson tells MFI, "I'm not sure you have to a giant, but I think scale will matter. I think you need resources to do technology. Many of our institutional clients want some sort of technological interface and some ways to see things online. Scale will matter for having the resources to do credit work. Scale will matter because of shareholder support and frankly, for navigating regulatory change. All those things, if you have sufficient scale you can have resources dedicated to do these sorts of things. We think that being of a certain size would be useful."

Q: Do you run cash pools beyond 2a-7? Mendelson answers, "We do. We run collective pools for securities lending collateral. We run it for our internal cash. Each of those funds will be different depending on the nature of the liabilities, the nature of the likely flows and the clients. We manage each of those in a somewhat different way. So they wouldn't all look just like a prime money market fund."

Q: Any thoughts on the PWG comment letters and next steps? Mendelson says, "Over fifty comment letters were submitted to the SEC, and they contain a number of interesting ideas that are worth further investigation and discussion. We assume that the SEC is going to review the comment letters that were submitted and then maybe seek additional comments. In addition, the FSOC has indicated that they will be discussing money market funds. Given the complexity of the issues, we do not expect an immediate decision. That said, we believe there will be additional changes. But at this time it is too soon to tell what those changes will be, or how quickly a decision will be made."

Q: Can you talk a little about your response letter to the PWG report? Mendelson responds, "We made several recommendations in our letter. First, we recommended further modifications to Rule 2a-7 surrounding investor concentration. Second, we proposed that the newly established FSOC financial oversight structure be used to identify and manage potential problems in a proactive manner by encouraging dialogue between industry participants and regulators. And finally, while we are supportive of some of the ideas presented by the industry, as detailed in our comment letter, we suggested a new structural approach to the industry in which money funds would hold capital. In addition, we are supportive of changes that have already been made to strengthen the money market industry, and we encourage all parties involved to consider the cumulative impact of these changes before we make additional changes to the industry."

The Investment Company Institute's latest reports show money fund assets declined modestly in January and fractionally during the latest week, while holdings of Government agency securities fell sharply last month. ICI's monthly "Trends in Mutual Fund Investing" for January 2011 shows total money fund assets falling by $75.6 billion, or 2.7%, to $2.728 trillion, while ICI's weekly "Money Market Mutual Fund Assets" shows money fund assets falling slightly after rising for two straight weeks.

The Institute's latest weekly report says, "Total money market mutual fund assets decreased by $5.14 billion to $2.751 trillion for the week ended Wednesday, February 23, the Investment Company Institute reported today. Taxable government funds decreased by $6.31 billion, taxable non-government funds increased by $3.02 billion, and tax-exempt funds decreased by $1.85 billion." This drop follows two consecutive weekly gains of $9.1 billion and $10.2 billion, respectively, which in turn followed five weeks in a row of outflows to start the year. Year-to-date through Feb. 23, money fund assets have decreased by $59 billion, or 2.1%.

ICI's monthly says, "The combined assets of the nation's mutual funds increased by $55.9 billion, or 0.5 percent, to $11.874 trillion in January, according to the Investment Company Institute's official survey of the mutual fund industry. In the survey, mutual fund companies report actual assets, sales, and redemptions to ICI.... Money market funds had an outflow of $75.63 billion in January, compared with an outflow of $9.45 billion in December. Funds offered primarily to institutions had an outflow of $64.73 billion. Funds offered primarily to individuals had an outflow of $10.91 billion."

The monthly figures through Jan. 31, 2011, show bond fund inflows slowing to almost zero (up $3.7 billion to $2.612 billion) after rising by $400 billion (18.1%) in 2010. Money market fund assets decreased by $512.1 billion, or 15.4%, in 2010. Meanwhile, stock fund assets gained $107.6 billion in January to $5.774 trillion, after increasing by $709.6 billion, or 14.3%, in 2010. Liquid assets (or "cash") in stock mutual funds remained near a record low of 3.5% in January. ICI's monthly statistics tracked 442 taxable money funds and 210 tax-free money funds in January 2011 vs. 475 taxable and 228 tax-free money funds a year ago.

ICI also released (to members only) its "Month-End Portfolio Holdings of Taxable Money Funds," which showed a sharp decline in U.S. Government Agency securities in January. Certificates of Deposit remain the largest holding in taxable money funds at $560.4 billion, or 23.3%. Repurchase Agreements, which increased by $18.9 billion to $507.9 billion, ranked second with 21.1% of assets, while Commercial Paper regained the third largest holding spot with $390 billion (16.2%). Government Agency securities dropped to fourth place among fund holdings with their decline of $32.9 billion to $378,039, or 15.7% of assets.

Paul Volcker recently added an after the buzzer comment letter to the SEC's website responding to the President's Working Group Report on Money Market Fund Reform. He says, "The widespread run on money market funds during the financial crisis illustrates the risk that is present in large financial institutions that operate with little or no capital and supervision, yet provide the very maturity transformation and liquidity 'service' expected from our regulated, well capitalized banking system. When the crisis hit, certain sponsors of Money Market Mutual Funds -- banks, investment banks, insurance companies and asset management firms -- injected significant amounts of capital into their Funds to preserve the par value of customers' investments."

He explains, "The purpose was both to protect the reputations of their respective firms and limit the contagious panic of investors withdrawing money at a rapid rate. Several of these sponsoring institutions, facing a shortage of capital and liquidity due to these and other losses during the crisis, received support from different government facilities including the TARP. The Prime Reserve Fund [sic], which operated independently, was the main direct recipient of government assistance via unprecedented use of the Exchange Stabilization Fund of the U. S. Treasury. Massive Federal Reserve purchases of commercial paper were driven by the need to protect MMMFs. Among these were well managed Funds that experienced a shortage of liquidity, and of course Funds that invested in poor quality securities."

Volcker continues, "The risk in these Funds has been compounded by the addition of cash management services, including withdrawal of fund principal on demand at par, thereby closely mimicking the services provided by regulated commercial banks. While the recent amendments to Rule 2a‐7 are a necessary first step towards increasing MMMF liquidity, I believe that a clear distinction should be drawn between our regulated commercial banks offering the right to withdraw funds on demand at par, and mutual funds that invest in credit instruments without comparable capital and liquidity requirements. As things stand, investors, particularly retail investors, may not be sensitive to this distinction, and the recent rescue of MMMFs by massive government assistance is a clear instance of moral hazard."

He says, "It seems to me an obvious and straightforward remedy to this situation is to provide for two distinct categories of MMMFs: MMMFs that desire to offer their clients bank-like transaction services, including withdrawal of funds from accounts at par, and promises of maintaining a constant or stable net asset value (NAV), should either be required to organize themselves as special purpose banks or submit themselves to capital and supervisory requirements and FDIC-type insurance on the funds under deposit. These 'Stable NAV' MMMFs would then be allowed to market themselves as offering redemption at par."

Volcker adds, "MMMFs that do not wish to follow this track can remain MMMFs but would not be authorized to market themselves as offering redemption at par; rather they could present themselves as a conservative, low risk, liquid investment product. These funds would not be allowed to use amortized cost pricing on the securities in their portfolio, with the implied result being a floating NAV. There would be no assurances that money in these accounts could be withdrawn at par. One idea set out in the President's Working Group Report that has merit is that the traditional $1.00 par value of these 'Floating NAV' Money Market Funds be increased to $10.00, to allow better visibility of price changes in the underlying securities."

He then says, "There is a theme throughout the President's Working Group Report on MMMFs with which I disagree, but is relevant to the future health of our financial system. The Report seems to suggest that if MMMFs were capitalized and regulated, money will flow out of these Funds predominantly to less regulated or unregulated 'substitutes'. On the contrary, I feel the natural and predominant destination for investors that seek secure, stable value, interest bearing financial products is the banking system. The yield spread between bank savings products and MMMF-redemption-at-par products would obviously tighten or be eliminated with capital, insurance and regulatory costs becoming a part of a stable NAV MMMF's cost structure. Thus an important potential additional benefit to the financial system as a result of applying new regulations of this type to MMMFs would be a banking system funded by an increased amount of stable, lower cost, deposits. This is not an insignificant factor to consider at a time when banking participation will be important to a restructuring of the residential mortgage market."

Finally, Volcker writes, "One benefit of age is, on occasion, having been present at a time relevant to today's debate. In my case I was at the Federal Reserve when MMMFs were born. It was obvious at the time that these products were created to skirt banking regulations -- a clear instance of regulatory arbitrage. The first of these Funds to require a bailout by a corporate parent in order to avoid 'breaking the buck' was in 1980. Since then an additional 145 more such bailouts have occurred, several of which directly or indirectly required governmental support. Prudent regulation of MMMFs is an important part of comprehensive financial reform, as both the Group of 30 and later the Treasury's White Paper so clearly had outlined."

This month, Money Fund Intelligence interviews BlackRock Managing Directors and new Co-Heads of Global Cash Management and Securities Lending, Rich Hoerner and Simon Mendelson. We ask the two veterans about BlackRock's recent mergers, about the company's excellent long-term safety record, and about recent hot topics involving money market funds. Excerpts from our Q&A follow:

Q: After all your fund mergers -- Merrill FFI, BGI, etc. -- is everything now 'one BlackRock'? Mendelson responds, "That's right. We've integrated. All the funds are being managed off a common platform, by a common portfolio management team, using a common set of guidelines, approved lists, etc.... We completed a formal fund merger in Europe to create a single fund family. We have not yet done that in U.S., but we are exploring those ideas. But for now we are all up and running on a common platform."

Q: How have the funds weathered the storm and crisis? Hoerner comments, "We are proud of our track record. Dating back to 1973, when TempFund was created, we've never, whether it was BlackRock or its predecessor, had to take steps to support the NAV at one of our 2a-7 funds. And that includes the most recent credit crisis. We place a lot of resources in credit research and risk management, and it's during times like 2007, 2008, when that investment and those resources really pay off."

He continues, "So, going back to 2007 we didn't own any of the problem SIVs. In 2008, we didn't own Lehman when it collapsed. We were able to withstand the redemption run in September 2008, largely because we were prepared for it. In the summer of 2008, we were growing increasingly concerned about the lack of liquidity in the market and about Sigma Finance, which was the last independent SIV that was still standing. Sigma was held in many money market funds, but not in BlackRock funds. [W]e had concerns about what would happen if Sigma had issues. As it turned out, all of the money fund holdings of Sigma were paid and it was Lehman Brothers that caused problems. We were pretty well positioned to make good on redemption requests."

Q: Are you surviving the yield drought? Does it help to be a giant with low yields? Hoerner replies, "I think it does. Our assets are skewed towards institutional, which, just given their lower expense ratio, and with the exception of treasury funds, still offer some sort of a return. Banks have been more aggressive going after retail money fund assets, as opposed to institutional assets. Institutional funds have weathered the storm better than the retail fund assets. That has certainly been a benefit given our mix of institutional and retail assets."

"Q: What is the biggest challenge today vs. historically in managing the funds? Mendelson answers, "The two biggest challenges in the industry today are the low yield environment and potential regulatory changes. The historically low yields make other options more competitive vs. money market funds, and it's just a difficult environment. The other big challenge, we believe, is the regulatory question and how that will play out. In addition to the SEC rule changes passed last year, there are a spectrum of additional ideas being considered. We have been discussing various options with policymakers in Washington, as well as with other managers and with clients. Our goal is to help get to a strengthened and more secure money market industry that continues to be attractive for issuers of commercial paper and investors in money market funds." Hoerner adds, "Given the fact that the industry is going through changes, we are spending more time talking about those changes with our clients."

The weekend Wall Street Journal featured "Why Investors Can't Get More Cash Out of U.S. Companies", which discussed the high levels of cash and corporate balance sheets and how the majority of it is trapped offshore. The Jason Zweig Intelligent Investor column said, "Earlier this month, Microsoft borrowed $2.25 billion in unsecured debt. What in the world possesses a company with $40 billion in cash and short-term securities to go out and borrow money? Rock-bottom interest rates are one reason. But the bizarre, byzantine U.S. tax code seems to be another."

The article explains, "Politicians have been carping about the more than $2 trillion in cash sitting idle in corporate coffers even as unemployment remains high. But much of that cash isn't in the U.S.; it is abroad. And it isn't likely to come back home unless U.S. tax laws change. David Zion, a tax and accounting analyst at Credit Suisse, estimates that the companies in the Standard & Poor's 500-stock index have 'north of $1 trillion' in undistributed foreign earnings, or profits that have been parked overseas to avoid U.S. tax."

The WSJ piece adds, "U.S. companies are taxed at up to 35% when they bring home the earnings generated through the operations of their overseas subsidiaries.... That can put firms in the peculiar position of having tons of cash offshore that they might need but can't use at home without taking a tax hit.... Congress and the White House are discussing whether the U.S. should follow the rest of the world and stop taxing repatriated offshore earnings from companies that already have paid taxes to foreign governments.... Meanwhile, investors should remember that a big chunk of cash on the balance sheet may look tempting but isn't necessarily there for the taking."

There has been some discussion recently about a temporary reprieve on taxes on the repatriation of this cash, which happened in 2004, but it doesn't look too promising. Forture writes in "Apple, Cisco, others organize for a tax holiday lobby", "A group of tech, pharmaceutical and energy giants is readying a major lobbying blitz for a tax holiday that would allow them to bring home the estimated $1 trillion they've got parked overseas at a steeply discounted rate."

In other news, the Financial Times quotes from Laurent Ramsey, chief executive of the Swiss-based Pictet Funds, "Unlike in the US, in Europe and Asia distribution is controlled by banks and it's a concentrated distribution market, therefore distributors have control of the clients. They have scale and have big power in negotiations, and therefore the fee sharing is more to their advantage.... In some cases you have to stick to your guns. Money market funds, net of fees, should deliver positive returns to clients. When investment returns go to zero it becomes difficult.... `We slashed fees to rock bottom levels but in doing so we had some distributors who said 'we are not really interested in your money market funds, we don't get anything because there is nothing there to give'. We lost a relationship."

Bloomberg writes "Hedge Funds May Pose Systemic Risk in Crisis, U.S. Report Says," which discusses which non-bank financial institutions will be designated "systematically important" by the new Federal Stability Oversight Council (or FSOC). The article says, "Hedge funds and insurers might threaten U.S. economic stability in a time of crisis, according to a report aimed at helping regulators decide which non-bank financial companies warrant Federal Reserve supervision."

While most of the article deals with hedge funds and insurers, there are some comments on money funds towards the end of the piece. Bloomberg says, "Money market funds, or MMFs, have systemic impact when they incur losses because the industry can be susceptible to runs, the report said. In 2008, the $62.5 billion Reserve Primary Fund became the biggest money-market fund and the first in 14 years to 'break the buck,' meaning the value of a share fell below $1 and investors faced losses. Reserve failed after investing in debt issued by Lehman Brothers Holdings Inc., the investment bank that declared the biggest-ever U.S. bankruptcy."

Under the subtitle, "Money-Market Funds," Bloomberg quotes the yet-to-be-released FSOC report, "Even a modest-sized MMF breaking the buck could, in principle, trigger a broad and damaging run.... However, no individual MMF may warrant designation applying the factors." The Dodd-Frank law listed a series of factors to determine what is "systematically important". (See Crane Data's Nov. 16, 2010, News "Comment Letters Argue Against Added FSOC Supervision for MMFs" or search for FSOC on for more.)

The Bloomberg story adds, "So-called liquidity funds, or unregistered money-market funds, suffered large investor withdrawals in 2007, the report said. It quotes the report, "Although these runs may have been disruptive, they do not appear to have become systemic." The article says, "If the funds grow rapidly there could be 'greater potential to pose systemic risk in the future.'

The Financial Stability Oversight Council website says, "As established under the Dodd-Frank Act, the Financial Stability Oversight Council (FSOC) will provide, for the first time, comprehensive monitoring to ensure the stability of our nation's financial system. The Council is charged with identifying threats to the financial stability of the United States; promoting market discipline; and responding to emerging risks to the stability of the United States financial system."

The President's Working Group Report on Money Market Fund Reform under its "Request for Comment," says, "The Commission requests comment on the Report. Comments received will better enable the Commission and the newly-established Financial Stability Oversight Council (which will be taking over the work of the PWG in this area) to consider the options discussed in this Report to identify those most likely to materially reduce money market funds' susceptibility to runs and to pursue their implementation. As the Report states, we anticipate that following the comment period a series of meetings will be held in Washington, D.C. with various stakeholders, interested persons, experts, and regulators to discuss the options in the Report."

Today, we excerpt again from the recently-released "Financial Crisis Inquiry Report," a 633-page report published to "examine the causes, domestic and global, of the current financial and economic crisis in the United States." (See our Jan. 28 Crane Data News, "Financial Crisis Inquiry Report Reviews Disruptions in Funding, MMFs", which covers the early subprime worries through the disaster that was Credit Suisse Institutional Money Market Prime Fund.) We feature pieces of the report mentioning money funds from the Fall of Bear Stearns to the Bankruptcy of Lehman Brothers.

On "The Fall of Bear Stearns (page 280) in March 2008, the report says, "After its hedge funds failed in July 2007, Bear Stearns faced more challenges in the second half of the year. Taking out the repo lenders to the High-Grade Fund brought nearly $1.6 billion in subprime assets onto Bear's books, contributing to a $1.9 billion write-down on mortgage-related assets in November. That prompted investors to scrutinize Bear Stearns's finances. Over the fall, Bear's repo lenders -- mostly money market mutual funds -- increasingly required Bear to post more collateral and pay higher interest rates. Then, in just one week in March 2008, a run by these lenders, hedge fund customers, and derivatives counterparties led to Bear's having to be taken over in a government-backed rescue."

On page 293, under the chapter "March to August 2008: Systematic Risk Concerns," the FCIC writes, "The most pressing danger was the potential failure of the repo market.... Moreover, if a borrower in the repo market defaults, money market funds -- frequent lenders in this market -- may have to seize collateral that they cannot legally own. For example, a money market fund cannot hold long-term securities, such as agency mortgage–backed securities. Typically, if a fund takes possession of such collateral, it liquidates the securities immediately, even -- as was the case during the crisis -- into a declining market. As a result, funds simply avoided lending against mortgage-related securities. In the crisis, investors didn't consider secured funding to be much better than unsecured, according to Darryll Hendricks, a managing director and global head of risk methodology at UBS, as well as the head of a private-sector task force on the repo market organized by the New York Fed."

Under "September 2008: The Bankruptcy of Lehman," the report writes, "On July 10, Federated Investors -- a large money market fund and one of Lehman's largest tri-party repo lenders -- notified JP Morgan, Lehman's clearing bank, that Federated would 'no longer pursue additional business with Lehman,' because JP Morgan was 'unwilling to negotiate in good faith' and had 'become increasingly uncooperative' on repo terms. Dreyfus, another large money market fund and a Lehman tri-party repo lender, also pulled its repo line from the firm."

It continued, "Fed Chairman Bernanke told the FCIC that government officials understood a Lehman bankruptcy would be catastrophic: We never had any doubt about that. It was going to have huge impacts on funding markets. It would create a huge loss of confidence in other financial firms. It would create pressure on Merrill and Morgan Stanley, if not Goldman, which it eventually did. It would probably bring the short-term money markets into crisis, which we didn't fully anticipate; but, of course, in the end it did bring the commercial paper market and the money market mutual funds under pressure. So there was never any doubt in our minds that it would be a calamity, catastrophe, and that, you know, we should do everything we could to save it."

"What's the connection between Lehman Brothers and General Motors?" Bernanke asked rhetorically. "Lehman Brothers' failure meant that commercial paper that they used to finance went bad." Bernanke noted that money market funds, in particular one named the Reserve Primary Fund, held Lehman's paper and suffered losses. He explained that this "meant there was a run in the money market mutual funds, which meant the commercial paper market spiked, which [created] problems for General Motors."

The Financial Crisis Inquiry Report continued, "As the financial industry came under stress," [Henry] Paulson told the FCIC, "investors pulled back from the market, and when Lehman collapsed, even major industrial corporations found it difficult to sell their paper. The resulting liquidity crunch showed that firms had overly relied on this short term funding and had failed to anticipate how restricted the commercial paper market could become in times of stress."

It continued, "Harvey Miller testified to the FCIC that '`the bankruptcy of Lehman was a catalyst for systemic consequences throughout the world. It fostered a negative reaction that endangered the viability of the financial system. As a result of failed expectations of the financial markets and others, a major loss of confidence in the financial system occurred.'"

Legg Mason CEO Mark Fetting, wrote a piece in yesterday's Financial Times entitled, "Not the time to meddle with money market funds". Fetting says, "During their 40-year history in the United States, money market funds have become a staple of the financial marketplace and a key component of the American economy. More than 750 US money market funds manage nearly $3,000bn on behalf of a wide range of investors -- state and local governments, colleges, non-profit institutions, businesses, and, of course, other individual investors."

He explains, "America's businesses and municipal governments depend on money market funds.... But for millions of individual investors, the value of money market funds is much simpler. For them, these funds mean stability, convenience, easy access to cash, and yields that historically have matched or exceeded those of competing cash products.... [F]amilies have benefited from the convenient cash-management services that money market funds offer -- cheque writing, sweeping up spare cash from brokerage accounts, ATM access, and easy transfer to other fund accounts."

Fetting writes in the FT piece, "Money market funds gave individual investors access to the money market rates that had been available only to major institutions. And that access has paid off. While today's yields are at record lows, the market-based returns on money market funds have paid investors $225bn more than they would have received from bank accounts over the last 25 years."

He says, "Money market funds' stability and convenience are grounded in a core principle -- dollar-in, dollar-out.... These funds can maintain a stable value because they invest in high-quality, liquid, short-term securities and manage portfolios to minimise swings in market value and credit risks. For investors, the result is a predictable, stable value in a fund that can be used for daily transactions without tax and record-keeping headaches. Little wonder that some $330,000bn has flowed in and out of money market funds since 1982, according to Investment Company Institute (ICI) calculations."

Fetting tells the FT, "Despite this record, some policymakers are floating the idea that funds should be forced to abandon the dollar-in, dollar-out principle. They argue that the stable $1 value creates a misperception about money market funds that should be addressed. Right now, the Securities and Exchange Commission is considering a range of reforms for money market funds, including ideas that would end the funds' stable $1 price. But money market investors have come out to tell the SEC why maintaining the stable net asset value is critical to the central role money market funds play, for their finances and for the economy."

He says, "We in the mutual fund industry believe that we can make money market funds even stronger while maintaining the features that are important to investors. We led the way with a round of proposals for tighter credit, maturity, and liquidity standards for these funds -- proposals that were echoed in new rules adopted last year by the SEC. Another safeguard -- ICI's proposal for a private emergency facility to provide liquidity to money market funds when markets are frozen -- enjoys widespread industry support. But we agree with our investors that forcing funds off the dollar-in, dollar-out principle could destroy money market funds while actually increasing risk to the financial system as a whole."

Finally, Fetting adds, "For 40 years, investors of all stripes and sizes have relied upon the stability, convenience, and market-based returns of money market funds. Given the economic uncertainties that many American families already face, now is not the time to undermine a product so central to their financial fortunes."

In recent weeks, both commercial paper and asset-backed commercial paper supply have rebounded after declining sharply the past 3 1/2 years. (See the Federal Reserve's "CP Outstanding" totals here.) With the market recovering, BofA Global Capital Management, manager of the BofA Money Funds (formerly the Columbia Money Funds) just published the timely, "Asset-Backed Commercial Paper: A Primer. The white paper, subtitled, "ABCP Delivers Several Benefits to Cash Investors, Enhanced Diversification and Attractive Yields Chief among Them," explains, "With diversification benefits, flexible terms, transparency, and a historic yield advantage relative to other cash investments, asset-backed commercial paper (ABCP) has been a sound addition to cash portfolios. In the Q&A below, Frank Gianatasio, a senior fixed income analyst at BofA Global Capital Management, describes the mechanics and potential benefits of ABCP.

The Primer asks, "Q. First, what is ABCP?" It answers, "A. ABCP is a short-term, senior-secured debt instrument collateralized by a variety of asset classes, such as credit card receivables, student loan payments and auto loan receivables. In the case of a specific ABCP credit, the investor's interest payments emanate from the pool of assets backing the credit, e.g., borrowers' monthly credit card payments. When the debt matures -- typically between 30 and 270 days -- the investor receives a principal payment that is funded either from the collection of the credit's assets, from the issuance of new ABCP or by accessing the credit's liquidity facility, a key feature of ABCP. Typically the liquidity facilities are structured to equal -- if not exceed -- the size of the ABCP program."

It continues, "Q. How is ABCP created? A. The issuance of ABCP begins with the seller of the security's underlying assets, e.g., a bank that wants to sell its credit card receivables or the financing arm of a car company that wishes to sell its auto loan receivables. The seller sells its receivables -- 'the assets' -- to a Special Purpose Vehicle (SPV), which is set up by a 'sponsor' (a bank or other financial institution) to issue ABCP. The SPV also is known as the 'conduit' because it is responsible for collecting and disbursing funds generated by the receivables to the ABCP credit's investors.... Thorough analysis of the strength of the sponsor is very important because the sponsor typically provides significant program-level credit enhancement and liquidity facilities that are designed to protect investors from potential credit losses and to provide liquidity in the event of a market disruption."

BofA Global's paper queries, "Q. What advantages does ABCP present relative to other cash investments? A. One major advantage is the diversification benefit, which accrues, to a large extent, from the risk profile of ABCP. First of all, ABCP investors are exposed primarily to the risks inherent in the underlying asset pools rather than the credit risk of a single financial institution or other issuer. Those underlying asset portfolios are well diversified. An ABCP issue may be backed by several distinct asset classes from a variety of sellers. This compares to standard commercial paper (CP) issued by a bank or other corporate entity, in which the investor is exposed to the risk of a downgrade of the issuer's debt or to an outright default by that issuer. The fact that ABCP is issued by the SPV helps insulate investors from the sponsor's other balance sheet risk. Therefore, in the event of a sponsor's bankruptcy, ABCP investors are not 'in line' with other creditors. Again, ABCP risk is secured by the underlying assets of the conduit, and investors have claim to those assets."

The Primer then asks, "Q. How does ABCP's yield compare to that of commercial paper? It says, "A. Historically ABCP yields have been higher than unsecured CP yields. This is somewhat counter-intuitive, as investors in ABCP earn more for taking a secured risk than a CP investor earns for taking an unsecured risk. The reason for that is that compared to CP, ABCP is understood and followed by a smaller group of investors. Some investment firms may not be sufficiently staffed or have the expertise necessary to analyze ABCP programs. The smaller buyer base means ABCP must offer a yield premium to attract investors. Money market funds can benefit from this slight pick-up in yield."

It adds, "Q. We saw during the global financial crisis that liquidity can dry up very quickly during a market disruption. How large and liquid is the ABCP market? A. As of January 28, 2011 there was $383.0 billion in ABCP outstanding, which accounts for approximately 35% of all commercial paper issuance in the U.S. Liquidity in the ABCP market is very robust. We know the market is broadly supported by many large institutional cash investors that are consistent buyers of ABCP, and there are at least two to three dealers on each ABCP program. In addition, every ABCP program is structured with at least 100% liquidity support so in the event of a market disruption, the liquidity facility can and would be drawn upon to repay maturing ABCP on a timely basis."

The Gianatasio piece also asks, "Q. In highlighting the advantages of ABCP over other cash investments, you mentioned the diversification benefits and the historical yield advantage. Are there any other reasons to include ABCP in a cash portfolio?" It explains, "A. For the managers of cash portfolios, the flexibility inherent in ABCP is an important benefit. ABCP is typically issued with maturities ranging from overnight to 270 days. This flexibility allows portfolio managers to customize their exposures to fit their overall portfolio construction strategy. Another important benefit is transparency. Unlike the holders of unsecured investments, ABCP investors can clearly see the assets they own within the conduit. Investors receive detailed monthly reporting that allows them to track portfolio performance and identify risks in a timely manner."

Finally, BofA Global says, "Q: Given the potential benefits ABCP can provide, do you suggest that cash investors include it in their portfolios? A. We believe clients for whom ABCP is appropriate should consider adding it to their portfolios. We believe that the ABCP market will continue to play an important role in the cash investment management business for years to come. ABCP is an important source of funding for banks and their clients, and ABCP investors benefit from a diversified, high quality, secured investment option that typically offers a yield pickup relative to the yield offered by unsecured CP."

We finally seem have gotten a breather in the recent heavy money market fund news cycle, and found time to go back and read some more of the Comment Letters on the President's Working Group Report on Money Market Fund Reform. Today, we excerpt from Karla M. Rabusch, President, Wells Fargo Funds Management, LLC. Wells writes in its letter, "We agree with the President's Working Group that the recent amendments to Rule 2a-7 under the Investment Company Act of 1940 adopted in January 2010 were an important first step in mitigating systemic risk, and commend the additional efforts undertaken to analyze certain other features of money market funds that could contribute to their susceptibility to significant redemption activity."

Rabusch says, "It is critical to preserve the structural integrity of money market funds as they have long played an important role in our nation's economy, providing both retail and institutional investors with a liquid and stable investment option, while at the same time providing a vital source of funding to businesses and municipalities. Money market funds also contribute to the health of the broader financial system. The most recent market dislocation that occurred in 2007-2008 and the resultant run on prime money market funds highlighted their susceptibility to market dynamics and exacerbated strains in the short-term funding markets."

She continues, "While we support some of the options presented in the PWG Report with certain modifications, we do not view any of the options presented, whether implemented individually or in combination, as a means to entirely eliminate systemic risk or the risk to money market funds of extreme redemption activity. However, we do believe that certain of the options discussed have the potential to further the resiliency of money market funds to certain market stresses. We believe it is critical to preserve the availability of stable value money market funds. While we do not oppose the idea of establishing money market funds with floating net asset values ... we do not support the wholesale replacement of money market funds that seek to price their shares at a stable $1.00 net asset value."

Wells also writes, "We believe that a backstop liquidity facility for money market funds is a desirable objective, recognizing that money market fund access to central bank funding through the Asset-Backed Commercial Paper Money Market Fund Liquidity Facility ('AMLF') was instrumental in halting the run on prime money market funds in 2008. The liquidity facility should be constructed and used in a manner that would prohibit money market funds from using borrowed funds for leverage or purposes other than meeting shareholder redemptions."

The letter continues, "While we believe that direct access to borrowing from the Federal Reserve through a mechanism similar to its discount window for banks is the most straightforward means of achieving this objective, we appreciate the desire expressed in the PWG Report that money funds should seek liquidity first from private sources. For this reason, we would be supportive of a collateralized liquidity facility which would provide liquidity to money market funds from a syndicate or consortium of banks through temporary loans collateralized by fund assets. We also appreciate the expressed concern that borrowing by money market funds to meet shareholder redemptions might leverage the credit risk on the remaining shareholders. For this reason, despite our conclusion that a collateralized liquidity facility is more desirable, we would be receptive to a private liquidity facility, but with several important caveats."

It explains, "First, we feel that it is important that sponsors of all participating funds be treated equally. As part of the broad agreement on capital and liquidity, Basel III, reached by the Group of Governors and Heads of Supervision at their meeting in September 2010, banks subject to supervision under this agreement will need to account for such things as contingent funding obligations associated with stable value managed funds in their Liquidity Coverage and Net Stable Funding Ratio calculations and hold liquid assets, stable funding, or capital accordingly. While the final rules need to be developed and are subject to the discretion of National Supervisors, the risks to the financial system posed by these obligations are the same irrespective of whether the sponsorship of the stable value fund is from a bank or non-bank. As a result, it would be reasonable for the liquidity facility to incorporate and adopt a consistent set of rules for bank and non-bank participants as regulatory rulemaking develops with respect to Basel III."

Rabusch adds, "There are many challenges to be faced in the design of a liquidity facility, including governance issues, a fair allocation of responsibility for the initial capital contribution and on-going commitment fees, the disposition of the capital of the bank in the event of a wind down, and the fact that because of its size, the liquidity facility would only be able to address the liquidity needs of a very limited number of funds and would not be able to meet the needs of the entire industry in the event of a run. In that event, only the resources of a central bank would be large enough. Yet, despite these drawbacks, we find the concept of back up liquidity to be attractive were it to be structured in a way that could successfully address these challenges."

Finally, Wells also comments, "While we do not agree that a two tier system would necessarily reduce systemic risks posed by money market funds, we do not oppose, as a means of providing enhanced investor choice, the possibility of two different money market fund structures to be regulated under Rule 2a-7. The importance of SNAV Funds is clear; the importance of VNAV Funds and their impact on the money market industry as a whole is somewhat less clear. That being said however, there are some advantages of VNAV Funds that are worth noting. Most significant are that the risks associated with VNAV Funds are factored into their transactional net asset value so that shareholders would take any resultant fund losses with them upon redemption. Such losses would not be leveraged, as they are in SNAV Funds, on shareholders who remain in the fund."

Money fund assets rose for the first time in 2011 in the latest week, breaking a five-week, $74 billion losing streak. ICI's "Money Market Mutual Fund Assets" report says, "Total money market mutual fund assets increased by $10.23 billion to $2.747 trillion for the week ended Wednesday, February 9, the Investment Company Institute reported today. Taxable government funds increased by $490 million, taxable non-government funds increased by $10.56 billion, and tax-exempt funds decreased by $820 million."

ICI's weekly continues, "Assets of retail money market funds decreased by $1.80 billion to $935.08 billion. Taxable government money market fund assets in the retail category decreased by $570 million to $165.21 billion, taxable non-government money market fund assets decreased by $800 million to $564.34 billion, and tax-exempt fund assets decreased by $430 million to $205.53 billion. Assets of institutional money market funds increased by $12.03 billion to $1.812 trillion. Among institutional funds, taxable government money market fund assets increased by $1.06 billion to $623.62 billion, taxable non-government money market fund assets increased by $11.36 billion to $1.069 trillion, and tax-exempt fund assets decreased by $390 million to $119.28 billion."

Year-to-date, money fund assets have declined by $63 billion, or 2.3%, with institutional assets accounting for $53 billion, or 84% of the total. Assets had remained rangebound within $50 billion of the $2.8 trillion level since May 2010 until last week when they dipped to $2.737 trillion. In 2010, money fund assets declined by $483 billion, or 14.7%, with almost all of the drop occurring in the first four months of last year. (Money funds dropped by over $100 billion in the first seven weeks of 2010.)

This followed asset declines of $537 billion, or 14.0%, in 2009, according to ICI's weekly statistics (the most comprehensive series available). Over the past 104 weeks (2 years), money fund assets have declined by $1.156 trillion, or 30.2%. But money fund totals overall have merely retreated to their levels of August 2007, at the start of the Subprime Liquidity Crisis.

Crane Data's Money Fund Intelligence Daily shows the modest recent asset recovery continuing, with money funds rising by $2 billion on Wednesday and $8.2 billion more on Thursday, February 10. We expect weather and higher than expected Fed funds effective rates to have played a role in the surprise resumption of outflows in January 2011. We believe that a long Holiday weekend with a quarterly tax payment date in the middle of January, coupled with the first of a series of blizzards on the East Coast, spiked demand for cash temporarily, and that the trends will remain more flat than down in coming weeks. (See also, The Wall Street Journal's "Money Funds Post Inflows".)

Brian Sack, Executive Vice President of The Federal Reserve Bank of New York, gave a speech yesterday at the Federal Reserve Bank of Philadelphia entitled, "Implementing the Federal Reserve's Asset Purchase Program", on the "implementation of the recent monetary policy decisions of the Federal Reserve and the associated implications for its balance sheet" and the recent "unconventional policy decisions of the Fed. Sack said, "In the second half of 2010, the FOMC made two important policy decisions about the size and composition of the Federal Reserve's balance sheet."

He explained, "In August, it decided to begin reinvesting the principal payments from its holdings of agency debt and mortgage-backed securities into longer-term Treasury securities, thereby keeping the amount of domestic assets held in the System Open Market Account (SOMA) portfolio unchanged at about $2 trillion. In November, the FOMC announced that it intended to expand the SOMA portfolio by purchasing an additional $600 billion of longer-term Treasury securities through the end of the second quarter of 2011, bringing the intended level of domestic securities holdings to $2.6 trillion. Those decisions were aimed at providing more monetary policy stimulus to the economy. The FOMC saw the additional stimulus as warranted because it viewed the progress toward its mandated objectives of full employment and price stability as disappointingly slow."

Sack continued, "But while the intention of the recent policy decisions may be similar to traditional monetary policy adjustments, the implementation of them is not. These policy decisions involve what are presumably some of the largest and most rapid portfolio adjustments that have ever taken place by any single financial market participant. To put it in perspective, note that these recent policy decisions involve the Federal Reserve purchasing, over an eight-month period, more Treasury securities than the amount currently held by the entire U.S. commercial banking system. It is therefore no small task to determine how to implement these purchases in an effective and responsible manner. That task falls to the Open Market Trading Desk (the Desk) at the Federal Reserve Bank of New York. Let me describe how the Desk has conducted those purchases and some of the issues that we have taken into consideration during the process."

He commented, "To achieve these objectives, the Desk relies on a system in which it purchases securities through reverse auctions with a set of established counterparties called the primary dealers. The securities that are eligible for each operation and an indication of the total size of the operation are announced in advance. Dealers then submit offers to sell those securities, either for their own accounts or on behalf of their customers, over a 45-minute period on the morning of the operation. Those offers are assessed by the Desk based on two criteria: their proximity to market prices at that time, and an internal methodology for comparing the relative value of the securities at the offered prices. This process occurs over a proprietary trading system called Fedtrade under the oversight of Desk staff, and the results are typically finalized and published within a few minutes of the close of the operation."

Sack also said, "Moreover, our purchases do not appear to be causing significant strains on the liquidity or functioning of the Treasury market. It is unusual for the market to have such a large, persistent, and one-sided participant, and we had to worry about how it would adjust to our presence. However, the available evidence suggests that market liquidity is decent at this time. Measures of liquidity, such as trading volumes, bid-ask spreads, or quote sizes, worsened in December, but that pattern appears to have been driven by year-end effects rather than our presence in the market. These measures have recovered since the year-end, moving back toward the levels observed before the start of the purchases."

Sack commented, "Since early November, one of the notable developments in financial markets has been the sharp increase in longer-term interest rates. At first glance, this change may seem at odds with the portfolio balance channel. However, it is important to understand the factors that led to the increase in interest rates in the current circumstances. The upward movement in longer-term interest rates in large part reflects the greater optimism among investors about the outlook for economic growth. Investors revised up their baseline forecasts for the economy and reduced the perceived downside risks that they see around that outlook. This shift in the outlook led the market to price in the possibility of earlier increases in short-term interest rates and to scale back the size of asset purchases that they expect from the Federal Reserve. Both of those developments contributed to the significant rise in yields."

In a section entitled, "Ensuring our Ability to Remove Policy Accommodation, Sack explains, "While the potential risks around the SOMA portfolio will not hamper the implementation of monetary policy, the size and duration of the portfolio will have to be taken into account when considering the appropriate policy strategy. In that regard, it is worth noting that, even as the Federal Reserve has been expanding its balance sheet, it has not lost any momentum in the preparation of its exit tools. When the FOMC eventually determines that the time to begin reducing policy accommodation has come, the critical tool will be the ability to pay interest on reserves. As has been discussed on many occasions, paying interest on reserves will allow the FOMC to control the cost of short-term credit even with an enlarged Federal Reserve balance sheet."

He added, "In addition, we continue to make considerable progress increasing our capacity to drain reserves if necessary. At this time, more than 500 depository institutions have registered for the term deposit facility. Those firms, in aggregate, hold nearly $600 billion of the reserve balances that are currently in the financial system. We also have added 58 money market funds as counterparties for reverse repurchase agreements, in addition to the 20 primary dealers that are our regular counterparties. Those money funds currently hold more than $1.5 trillion of assets, with a good portion of those assets in the type of short-term repurchase agreements that we would be offering. In short, we have already established considerable capacity to drain reserves with these two tools, and we will continue to advance them in productive directions."

Finally, he said, "My purpose today was to provide information on the manner in which the Desk has conducted the asset purchases that the FOMC has decided to pursue and the associated implications for financial markets and the Federal Reserve's balance sheet. On the whole, I believe that the recent asset purchases by the Federal Reserve have had helpful effects on financial conditions and have been implemented in a manner that has been flexible enough to avoid any significant negative consequences for the functioning of financial markets. Moreover, while the programs have resulted in significant changes to the characteristics of the SOMA portfolio, those changes will not impede the ability of the Federal Reserve to adjust the degree of policy accommodation when judged appropriate by the FOMC."

The Federal Deposit Insurance Corporation issued a statement entitled, "FDIC Approves Final Rule of Assessments, Dividends, Assesment Base and Large Bank Pricing," which says, "The Board of Directors of the Federal Deposit Insurance Corporation (FDIC) today approved a final rule on Assessments, Dividends, Assessment Base and Large Bank Pricing. The rule implements changes to the deposit insurance assessment system mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act and revises the assessment system applicable to large banks to eliminate reliance on debt issuer ratings and make it more forward looking. Dodd-Frank required that the base on which deposit insurance assessments are charged be revised from one based on domestic deposits to one based on assets." (See the full "Final Rule of Assessments, Dividends, Assessment Base, & Large Bank Pricing" here.)

The FDIC's release continues, "In November 2010, the Board approved a proposed rule to change the assessment base from adjusted domestic deposits to average consolidated total assets minus average tangible equity and reissued a proposed rule revising the deposit insurance assessment system for large institutions that was approved by the FDIC in April 2010. The Board approved a proposed rule on Assessment Dividends, Assessment Rates and the Designated Reserve Ratio in October 2010. The final rule encompasses all of these proposed rules."

Chairman Sheila Bair says, "This final rule accomplishes Dodd-Frank's goal of better reflecting risks to the deposit insurance fund, while also providing the industry greater certainty regarding what rates will be over the long run. By changing the assessment base from deposits to assets minus tangible equity, the Act allows the FDIC to charge deposit insurance assessments on secured liabilities, which we have always protected. The rule should keep the overall amount collected from the industry very close to unchanged, although the amounts that individual institutions pay will be different."

The release explains, "The new large bank pricing system will result in higher assessment rates for banks with high-risk asset concentrations, less stable balance sheet liquidity, or potentially higher loss severity in the event of failure. Over the long term, large institutions that pose higher risk will pay higher assessments when they assume these risks rather than when conditions deteriorate."

Bair adds, "The new large bank pricing system in this final rule goes a long way towards reducing pro-cyclicality by calculating assessment payments using more forward-looking measures.... In light of the interest rate environment and the assessment rate benefit we provide, I encourage banks to issue more long-term unsecured debt to lock in low rates and provide greater stability to their funding."

Finally, the FDIC says, "The final rule also revises the assessment rate schedule effective April 1, 2011, and adopts additional rate schedules that will go into effect when the Deposit Insurance Fund (DIF) reserve ratio reaches various milestones. These future rate schedules should accomplish the goals of maintaining a positive fund balance, even during periods of large fund losses, and maintaining steady, predictable assessment rates throughout economic and credit cycles."

The latest issue of Money Fund Intelligence, Crane Data's flagship monthly publication, features the articles entitled, "RIP Floating NAV? Battle Now Over Liquidity Bank," which discusses comment letters on the President's Working Group Report on Money Market Fund Reforms and future regulation of funds; "BlackRock's New Co-Heads of Cash Speak," which interviews money fund veterans Rich Hoerner and Simon Mendelson; and, "Funds See Shadow NAVs, Surprisingly Few < 1.0000," which discusses the recent release of money funds' Form N-MFP and fund's "shadow" prices. Our monthly newsletter also features money fund news, performance tables, rankings, our Crane Indexes and top-performing fund tables.

The RIP Floating NAV piece says, "Though nothing of course is certain, the latest batch of comment letters on the President's Working Group Report on Money Market Fund Reform makes it clear that the idea of a floating NAV for money funds continues to be wildly unpopular. The letters, most of which were posted on the January 10th deadline, almost unanimously opposed the concept of a floating rate NAV. Given that this was the idea's second chance to gather support, and it again failed miserably, we think we can now say, 'Rest in peace.'" We quote letters from Dreyfus, JPMorgan, Fidelity, and USAA.

The BlackRock Profile states, "This month, Money Fund Intelligence interviews BlackRock Managing Directors and new Co-Heads of Global Cash Management and Securities Lending, Rich Hoerner and Simon Mendelson. We ask the two veterans about BlackRock's recent mergers, about the company's excellent long-term safety record, and about recent hot topics involving money market funds." Look for excerpts from our Q&A in coming weeks.

MFI also discusses the new "shadow" NAV disclosures. The article says, "Last week, the U.S. Securities & Exchange Commission began posting money market mutual funds' new Form N-MFP, monthly filings which contains "shadow" NAVs delayed by 60 days. The S.E.C. writes, '[I]nvestors can for the first time access detailed information that money market funds file with the Commission -- including information about a fund'​s investments and the market-based price of its portfolio known as its 'shadow NAV' (net asset value) or mark-to-market valuation.'"

The piece explains, "Starting with the current February issue, Crane Data has added shadow NAV statistics to our monthly Money Fund Intelligence XLS (available to subscribers only). Our initial collection of the Nov. 30 shadow NAV prices show that just 105 out of the 761 funds we've collected so far, or 12.​7%, show shadow NAVs of $0.​9999 or lower. Almost half of these (50) have mark-to-market prices of 0.9999 and the rest have NAVs ranging from 0.9998 to 0.9979. Just 6 are below 0.9990."

Finally, MFI's "Money Fund News" also features briefs about money fund assets falling to $2.7 trillion, Moody's backing away from its controversial money fund ratings proposals, the NY Fed lowering its reverse repo counterparty criteria, and more. Crane Data's Money Fund Intelligence is $500 a year and includes access to archived issues and additional tools via E-mail Kaio for a sample issue or call 1-508-439-4419 to subscribe.

Watch for the February issue of our Money Fund Intelligence to come out later this morning along with performance information from Jan. 31, 2011, and "shadow" NAV information from Nov. 30, 2010.... On Friday, Fixed-Income Strategist Garret Sloan of Wells Fargo Securities wrote, "Monday will be a watershed moment in the U.S. banking system if the FDIC comes out with its final recommendation for deposit insurance assessments. The structure and magnitude of the assessment could dramatically change the way that banks pay for depositor protection. The preliminary FDIC model shows that the new assessment will be a very holistic way of treating bank depositor risk by considering both the asset and liability side of the balance sheet rather than simply charging a flat fee on total domestic deposits. The change could cause some relatively significant short-term market changes."

He explains, "First, there is the possibility that depositors will begin assessing the relative riskiness of their banks based on the relative magnitude of FDIC insurance premiums. The result could potentially entice risk-averse depositors to move assets to banks they consider less risky (i.e. lower FDIC assessment per dollar of deposits). A second potential outcome may be the movement of capital out of banks and into money funds, separate accounts and direct investments where FDIC insurance fees are not levied. The assessment raises the potential that both earnings credits and interest paid on money market deposit accounts and offshore deposits could decline in order to compensate banks for additional FDIC premiums."

Sloan continues, "A third potential outcome may be a change in the competitive fee landscape. Each bank will likely be required to strategically determine their relative pricing power in passing on new fees to clients. In that discussion the ability to justify charging higher credit spreads to make up for depositor insurance will need to be addressed. But the corollary to this argument is how a bank justifies charging higher depositor fees to clients because the asset side of the bank's balance sheet is relatively more risky according to the FDIC model. The holistic approach from the FDIC seems to leave all of these alternatives on the table. In short, the potential for banking to become more expensive on both the transaction and credit extension side is possible."

Finally, he says, "A fourth potential outcome is the way in which banks fund themselves. The current proposal from the FDIC would assess fees at the IDI (Insured Depository Institution) level. Some institutions that conduct repo transactions out of the bank may look to curtail sources of funding that pledge specific assets ahead of depositors in a wind-down situation. Such sources of funding in the preliminary FDIC model would likely raise assessment fees -- all else equal. The result could likely be a decrease in bank repo, or at least GC repo rates and a potential uptick in Fed funds market activity."

The U.S. Securities & Exchange Commission took action against TD Ameritrade and its sales of the "enhanced cash" Reserve Yield Plus Fund. This follows an earlier SEC action against Charles Schwab over "misleading statements" and its YieldPlus Fund. Yesterday, the Commission issued a press release entitled, "SEC Charges TD Ameritrade for Failing to Supervise Its Representatives Who Sold Shares of the Reserve Yield Plus Fund.

The release says, "The Securities and Exchange Commission today charged TD Ameritrade Inc. for failing to reasonably supervise its registered representatives, some of whom misled customers when selling shares of the Reserve Yield Plus Fund, a mutual fund that "broke the buck" in September 2008. According to the SEC's order, TD Ameritrade's representatives offered and sold the fund through the firm's various sales channels prior to Sept. 16, 2008. The order finds that a number of the representatives violated the securities laws when they mischaracterized the fund as a money market fund, as safe as cash, or as an investment with guaranteed liquidity."

It continues, "They also failed to disclose the nature or risks of the fund when offering the investment to customers. TD Ameritrade failed to prevent the misconduct by its representatives because it did not establish adequate supervisory policies and procedures or a system to implement them with respect to the offers and sales of the fund. To settle the SEC's charges, TD Ameritrade has agreed to distribute approximately $10 million to eligible customers who continue to hold shares of the fund."

The statement added, "The SEC's administrative order finds that the Reserve Yield Plus Fund sought to provide higher returns than a money market fund while seeking to maintain a net asset value (NAV) of $1.00. The fund's NAV fell to 97 cents on Sept. 16, 2008, after the Reserve wrote down the fund's investments in commercial paper issued by Lehman Brothers Holdings Inc."

A January 11 release, "SEC Charges Schwab Entities and Two Executives With Making Misleading Statements Schwab Entities to Pay More Than $118 Million to Settle SEC Charges, says, "The Securities and Exchange Commission today charged Charles Schwab Investment Management (CSIM) and Charles Schwab & Co., Inc. (CS&Co.) with making misleading statements regarding the Schwab YieldPlus Fund and failing to establish, maintain and enforce policies and procedures to prevent the misuse of material, nonpublic information. The SEC also charged CSIM and Schwab Investments with deviating from the YieldPlus fund's concentration policy without obtaining the required shareholder approval."

Robert Khuzami, Director of the SEC's Division of Enforcement said, "All financial firms and professionals -- including large mutual fund providers -- must be vigilant in accurately describing the risks of the products they sell to the public, especially the widely-held mutual funds that are the bread-and-butter investments of retail investors." Antonia Chion, Associate Director of the SEC's Division of Enforcement, adds, "Schwab marketed the fund as a cash alternative with only slightly more risk than a money market fund even though, at one point, half of the fund's assets were invested in private-issuer, mortgage-backed and other securities with maturities and credit quality that were significantly different than investments made by money market funds."

Finally, the SEC says, "The YieldPlus Fund is an ultra-short bond fund that, at its peak in 2007, had $13.5 billion in assets and more than 200,000 accounts, making it the largest ultra-short bond fund in the category. The fund suffered a significant decline during the credit crisis of 2007 and 2008. Its assets fell from $13.5 billion to $1.8 billion during an eight-month period due to redemptions and declining asset values."

The London-based Institutional Money Market Funds Association, or IMMFA, a group which represents U.S.-style money funds in Europe, issued a press release this morning which says, "A research report published jointly today by the Institutional Money Market Funds Association (IMMFA) and PwC Luxembourg shows that triple-A rated funds have deepened the money markets, by virtue of the volume and proportion of assets held by the funds. The 30-page report, entitled, "The contribution of IMMFA funds to the Money Markets: A report commissioned to PwC by the Institutional Money Market Funds Association (IMMFA)," claims that "IMMFA funds have enabled significant growth of the Commercial Paper (CP) market."

The IMMFA press release explains, "As at June 2010, IMMFA funds held over 16% of the outstanding Euro-denominated CP (EUR 33 bn), 5% of outstanding US dollar-denominated CP (EUR 35 bn) and EUR 37 bn of Sterling-denominated CP. Additionally, IMMFA funds helped develop the market for Certificates of Deposit (CDs). The funds more than quadrupled their market share of outstanding Euro-denominated CDs over the past five years, to 8% as at June 2010 (EUR 29bn), and concurrently almost doubled their market share in US dollar-denominated CDs to 6% (EUR 62 bn), during a period of substantial growth in the size of both markets. The report concludes that continued growth of IMMFA funds is likely to result in further enhancements to the money markets."

Chief Executive Gail Le Coz comments, "This research report confirms the important and positive role of IMMFA funds. By purchasing short-term debt, deposits and Treasury bills, IMMFA funds provide key funding for companies, governments and households on a daily basis. These funds make a major contribution to the money markets and therefore to the European and the American economies."

Dariush Yazdani, Head of the Asset Management Research unit of PwC Luxembourg, says, "The triple-A rated Money Market Funds represented by IMMFA are an intrinsic component of the money markets. It is evident from the data that IMMFA funds help facilitate several short-term debt markets, and if growth in assets follows the rising trend, they should remain a key participant in the money markets."

The IMMFA/PwC Report says, "Money Market Funds (MMFs) have grown to represent almost one third (EUR 5.8 tn) of the global funds industry at their recent peak. Within this segment, IMMFA funds alone have almost doubled their assets under management (AUM) over the last five years, accounting for EUR 458 bn by mid-2010. MMFs perform a vital role within the global economy. By purchasing commercial paper (CP), deposits and treasury bills (T-Bills), MMFs provide key funding for companies, governments and households on a daily basis. On a macroeconomic level, we have found that IMMFA funds contribute significantly to M3 in various economic regions, particularly the UK. These funds contribute: 6.5% of M3 to the UK economy; 1.8% of M3 to the US economy; and 1.5% of M3 to the Eurozone economy."

It adds, "Specifically within the money markets, IMMFA funds have deepened the CP and certificate of deposit (CD) markets, particularly in Europe. The volume of CP and CDs held by IMMFA funds has increased dramatically compared to the market size over the last five years. However, due to a larger and more liquid market for other money market instruments, IMMFA funds have not as yet had the same impact on the T-Bill, repurchase agreement (Repo), time deposit (TD) or floating rate note (FRN) markets."

The study includes some background on IMMFA money funds and includes statistics on the sizes of various money market segments in Europe. Finally, the PWC report says, "Approximately 90% of the global MMF market is divided between the US and European money markets, with the US share forming approximately two thirds of this. Within the European region, France, Luxembourg and Ireland hold 86% of MMF domiciliation between them."

Yesterday, mutual fund news website mentioned a recent study, "Reducing Systemic Risk: The Role of Money Market Mutual Funds as Substitutes for Federally Insured Bank Deposits," written by `Jonathan Macey of Yale Law School. The paper's Abstract says, "In the wake of the events of September 2008, money market mutual funds have made significant changes to the way they invest. Those changes have been driven by business and investment needs as well as by substantial revisions to the regulatory framework in which funds operate. Yet, some policymakers and market participants are calling for additional regulatory or legislative action. This paper lays out the important role that money market mutual funds play in the short-term capital markets, traces the successful regulatory history of money market mutual funds and argues that more reforms could create, rather than reduce, systemic risk."

The summary continues, "The first phase of these changes involved a number of amendments to Rule 2a-7, which governs the operation of mutual funds. The final rule changes released by the SEC in February 2010 included, among other things, tightened limits on portfolio maturity, greater disclosure obligations and heightened responsibilities for boards of money market funds."

It explains, "When announcing the new rules in January 2010, SEC Chairman Schapiro indicated a possible second phase of reform that could include other 'more fundamental' changes that the SEC would examine: a floating net asset value (or NAV), more frequent disclosure of mark-to-market NAVs, mandatory redemptions-in-kind for large redemptions, a private liquidity facility and a two-tiered system of money market funds in which the NAVs for some funds would float and the NAVs for others would not."

Macey writes, "The Obama administration is also examining possible changes to money market funds. In June 2009, the administration instructed the President's Working Group on Financial Markets to study whether fundamental changes are needed to reduce the susceptibility of money market funds to runs, including possibly prohibiting money market funds from relying on a stable NAV. These reforms are being considered at a time when others, such as former Federal Reserve Board Chairman Paul Volcker, have called for money market funds to be regulated like banks."

He says, "Missing from the debate so far has been an acknowledgment of the enormous benefits that money market funds have provided over the last 40 years, both to investors and to the financial system as a whole. For both individual and institutional investors, money market mutual funds provide a commercially attractive alternative to bank deposits. Money market funds offer greater investment diversification, are less susceptible to collapse than banks and offer investors greater disclosure on the nature of their investments and the underlying assets than traditional bank deposits. For the financial system generally, money market mutual funds reduce pressure on the FDIC, reduce systemic risk and provide essential liquidity to capital markets because of the funds' investments in commercial paper, municipal securities and repurchase agreements."

It adds, "Despite these benefits, the changes under consideration, particularly a floating NAV, likely would curtail significantly, or potentially eliminate altogether, the money market fund industry as we know it. In this paper, I explore the advantages that funds have offered and the risks to the financial system from destabilizing the money market fund industry through these so-called reforms."

Macey continues, "I describe in detail some of the advantages of money market funds, which I believed have been overlooked in the current policy debate. In particular, I discuss the following: Money market funds reduce pressure on the FDIC.... Money market funds provide an alternative to bank deposits without the need for FDIC insurance..... [M]oney market funds do not suffer from the same structural mismatch between their assets and liabilities because of the liquidity and maturity requirements of Rule 2a-7. Money market funds reduce systemic regulatory risk: Having all short-term savings subject to one regulatory regime creates systemic risk.... Money market funds provide valuable liquidity by investing in commercial paper, municipal securities and repurchase agreements: Money market funds are significant participants in the commercial paper, municipal securities and repurchase agreement (or repo) markets.... In light of the many benefits that money markets funds provide, policymakers should be careful not to disrupt the operations of the money market industry by making more fundamental changes."

Finally, the Abstract says, "Like all regulatory regimes, policymakers should evaluate periodically whether improvements can be made. In the case of money market funds, those improvements should come within the context of Rule 2a-7, should not alter the basic structure of the funds and should not seek to impose arbitrarily a regulatory regime designed for a fundamentally different type of entity. The proponents of more fundamental changes claim that they would reduce systemic risk. However, changes such as abandoning the stable $1.00 NAV could end the money market fund industry by causing a massive inflow of money to banks, which would increase the overall risk of the financial system."

Earlier today, the U.S. Securities & Exchange Commission began posting money market mutual funds' new Form N-MFP, a monthly filing which contains "shadow" NAVs delayed by 60 days. A press release, entitled, "SEC Releases Money Market Fund Portfolio and 'Shadow Nav' Information to the Public," says, "The Securities and Exchange Commission today announced that investors can for the first time access detailed information that money market funds file with the Commission -- including information about a fund's investments and the market-based price of its portfolio known as its "shadow NAV" (net asset value) or mark-to-market valuation."

Crane Data's initial collections of the Nov. 30 shadow NAV prices show that just 30, or 12.7%, of the 236 taxable money market mutual funds with assets over $1 billion show shadow NAVs of 0.9999 or lower. Half of these (15) have mark-to-market prices of 0.9999 and the rest have NAVs ranging from 0.9998 to 0.9984. Just 3 are below 0.9991, and these are still well above the threshold where a price would be in danger of "breaking the buck". (A fund would need to be priced at 0.9949 to round down to 0.99.) Note that Crane Data will begin publishing the full list of "shadow" NAVs in our monthly Money Fund Intelligence XLS, which is available to subscribers only. (We also recently began publishing Money Fund Portfolio Holdings in our Money Fund Wisdom database.)

The SEC's release continues, "The information is available on the SEC's website and will be updated monthly. As part of its overhaul of money market fund regulation, the Commission last year adopted a rule requiring money market funds to file information about their holdings and portfolio valuations." "While the Commission uses this information in its real-time oversight of money market funds, we also believe that public disclosure can provide investors and market analysts with useful insight for their evaluation of these funds," comments SEC Chairman Mary L. Schapiro.

The SEC explains in a "Frequently Asked Questions" piece, "Q: Under new SEC rules, money market funds must report their portfolio holdings and other information to the SEC on Form N-MFP. Will this information be available to the public? A: Yes, on a 60-day delayed basis. Rule 30b1-7(b) states that the "Commission will make the information filed on Form N-MFP available to the public 60 days after the end of the month to which the information pertains." For example, information reported on Form N-MFP for November 2010 will be available 60 days after November 30.... More recent but less detailed information about money market fund portfolio holdings is available on fund websites, and that information must be posted within 5 business days after the end of the month."

The SEC continues, "Q: How do I find the publicly available information that money market funds file on Form N-MFP? A: Information filed on Form N-MFP will be available on the Commission's Electronic Data Gathering, Analysis and Retrieval web page ("EDGAR"), which is at You can retrieve the information in different ways, including a readable format in which information corresponds to the items of the form, or the data format the fund used to submit the information to the Commission (eXtensible Markup Language or "XML"). Useful links on the Commission's website include "Search for Company Filings" (, where you can enter the fund's ticker symbol. You can also find links to this information through money market funds' websites that include portfolio holdings information. In addition, it is likely that financial publications will include some of the publicly available information filed on Form N-MFP by money market funds."

The Q&A also asks, "Q: Money market funds report the "shadow price" of their net asset value ("NAV") per share on Form N-MFP (Items 18 and 25). What is a shadow price? A: A money market fund's shadow price is the NAV per share most recently calculated using available market quotations (or an appropriate substitute that reflects current market conditions). In other words, it is the NAV that reflects the current market value of the securities the fund owns, rather than the amortized cost of those securities. SEC rules permit a money market fund to value its securities at cost and spread out (or amortize) any discounts given or premiums paid on the securities when the fund acquired them. SEC rules also permit a fund to round the cost-based NAV to the nearest penny per share. Both of these provisions, combined with the strict limits on money market fund investments under SEC rules, enable a money market fund to maintain a stable NAV, typically $1 per share."

It continues, "Q: What does it mean if a money market fund's shadow price NAV differs from the $1 per share at which the fund sells and redeems its shares? A: Because the markets are constantly changing, a money market fund's market based (shadow price) NAV is constantly changing too. Therefore it is not uncommon for a fund's shadow price NAV per share to differ from exactly $1.0000 per share, for example due to interest rate changes that affect securities values in a fund's portfolio. As long as the fund's shadow price NAV per share is at least 99 1/2 cents (or $0.995) and no greater than 100 1/2 cents (or $1.005), the fund can continue to sell and redeem shares at $1 per share. If a money market fund's shadow price NAV per share goes outside these limits, the fund may need to re-price its shares at a value other than $1 per share, an event known as "breaking the buck." In the past couple of decades since money market funds began, two money market funds have broken the buck. It is also important to remember that the shadow price NAV shown on publicly available Form N-MFP information is at least 60 days old and is likely not the fund's current shadow price NAV. More recent monthly information (including portfolio holdings but not necessarily including shadow prices) is available on money market fund websites. Some money market funds post information on their websites more often than monthly.

Finally, the SEC asks, "Q: Where can I find out more about money market funds, net asset values, etc.? A: SEC publications you may find useful include: Investor Bulletin: Focus on Money Market Funds, and, Mutual Funds: A Guide for Investors." You can search for filings on mutual funds and Form N-MFP via EDGAR's Mutual Fund search page at of by reviewing recent Form N-MFP filings here.

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