​

The Investment Company Institute'​s most recent official monthly asset flow numbers verify that money fund assets fell sharply in June 2012. ICI'​s latest monthly "Trends in Mutual Fund Investing: June 2012" showed that money market mutual fund assets declined by $​45.​8 billion in June to $​2.​514 trillion. Money fund assets now account for 20.​7% of overall mutual fund assets. Bond fund assets continued higher, rising by $​33.​9 billion to $​3.​169 trillion, or 26.​0% of assets. ICI'​s "Month-​End Portfolio Holdings of Taxable Money Market Funds showed declines in every segment except Treasuries and Goverment Agencies in June. The Institute also shows (​separately) in a "Prime Money Market Funds' Holdings Update" that "Eurozone Holdings Drop Close to December Levels."

ICI'​s latest "​Trends" says, "The combined assets of the nation'​s mutual funds increased by $​208.​5 billion, or 1.​7 percent, to $​12.​171 trillion in June, 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.... Bond funds had an inflow of $​16.​25 billion in June, compared with an inflow of $​18.​96 billion in May.... Money market funds had an outflow of $​46.​40 billion in June, compared with an inflow of $​2.​01 billion in May. Funds offered primarily to institutions had an outflow of $​40.​74 billion. Funds offered primarily to individuals had an outflow of $​5.​66 billion."

In July, month-​to-​date through 7/​29, assets have rebounded by $​27.​9 billion, according to Crane Data'​s Money Fund Intelligence Daily. YTD, we show asset declines of $​136.​1 billion, or 5.​3%. Our daily series shows the rebound concentrated in Prime Institutional funds in July; they'​ve regained $​31.​1 billion, or 4.​0%, month-​to-​date.

ICI'​s Portfolio Holdings series shows Repurchase Agreements dropping in June after rising in April and May (​down $​48.​9 billion to $​519.​1 billion). Repos remain the largest portfolio holding among taxable money funds with 23.​1% of assets. Treasury Bills & Securities remained the second largest segment at 20.​2%; holdings in T-​Bills and other Treasuries rose by $​21.​0 billion to $​453.​9 billion. Holdings of Certificates of Deposits, which rank third among portfolio holdings, decreased by $​8.​2 billion to $​389.​9 billion (​17.​4%).

U.​S. Government Agency Securities rebounded by $​21.​5 billion to reclaim the fourth largest segment of taxable money fund portfolio holdings with $​341.​6 billion, or 15.​2% of assets. Commercial Paper declined by $​18.​5 billion to $​333.​3 billion, which dropped CP to the fifth largest composition sector with 14.​8% of assets. Notes (​including Corporate and Bank) accounted for 5.​3% of assets ($​118.​9 billion), while Other holdings accounted for 3.​7% ($​83.​5 billion).

The Number of Accounts Outstanding in ICI'​s Holdings series for taxable money funds decreased to 25.​26 million from 25.​44 million the month before, while the Number of Funds fell by 4 to 413. The Average Maturity of Portfolios remained flat at 46 days in June. (​Note that the archived version of our Money Fund Intelligence XLS monthly spreadsheet -- see our Content Page to download -- now has its Portfolio Composition and Maturity Distribution totals updated as of June 30, 2012. We revise these following the monthly publication of our Money Fund Portfolio Holdings data.)

Finally, ICI'​s latest "Prime Money Market Funds' Holdings Update: Eurozone Holdings Drop Close to December Levels" says, "Prime money market funds reduced their holdings of eurozone issuers to 12.​2 percent of assets in June from 15.​5 percent of assets in May (​chart). The decline of more than 3 percentage points puts eurozone holdings close to the trough of 12.​0 percent seen in December 2011. The June decline was driven primarily by reductions in French, German, and Dutch holdings (​table), and 80 percent of French holdings mature in 30 days or less."

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On Friday morning, Federated Investors hosted its latest quarterly earnings call, and, as usual, President & CEO Chris Donahue weighed in on a number of issues impacting the money market mutual fund business. (See call transcript here.) Donahue says in his remarks, "On the regulatory front, it has been reported that a document outlining new money market fund regulations is being circulated by the SEC Chairman to the other commissioners. While the proposal is not publicly available, prior comments from the Chairman indicate that the proposal includes the choice of floating the NAV or imposing redemption restrictions on money funds, in combination with capital requirement at the fund level. These ideas have been previously floated and even in their discussion form ... have drawn extensive negative reaction and commentary from money fund investors, issuers, businesses, state and local municipal finance authorities, various members of Congress, the U.​S. Chamber of Commerce, the ICI and individual money fund management companies."

He continues, "The reason is ... because it'​s very poor policy. I have previously covered these proposals and won'​t go into a lot of detail today except to say, that so far as they violate the primary tenant of a money fund daily liquidity at par with a market yield, they will end money market funds as we know them if they are proposed and enacted. The consequences will be severe, including higher funding cost for states, municipalities and other government entities, leading to either higher taxes, cuts in services or more money moving into the largest, already too-​big-​to-​fail banks, and money moving to far less transparent, and less regulated investments, including separate accounts, offshore accounts, and things perhaps we have not even thought of."

Donahue explains, "These draconian measures are based on demonstrably false premise that money funds are prone to destabilizing runs [​and are] somehow backed by the taxpayers. There is no proof that either of these ideas is true. There is however the unparalleled 40 year record of successful money management providing real tangible benefits to our financial system. So again we advocate [​that] the regulators study the positive impact of the 2010 Rule 2a-​7 amendments and conduct a thorough and rigorous cost-​benefit analysis of any further money fund regulation. The facts will then show that further rules are not necessary, and in fact are likely to do serious harm to our financial system."

He also tells analysts, "We just announced this week that Federated was awarded the contract to manage the $​9.​5 billion Massachusetts Municipal Depository Trust. The MMDT provides liquidity and bond management and provide these services for the state and several independent authorities and approximately 290 municipalities in Massachusetts. This is an important win for Federated and we look forward to providing Massachusetts with a range of high quality services. We expect to develop additional state pool opportunities to add to our market leading presence. We expect to begin managing these assets by year-​end."

Donahue comments, "As regard acquisitions and offshore business, the integration of the recently closed London-​based Prime Rate Capital Management operation is largely completed. Assets at quarter end were $​4.​2 billion. The Prime Rate Capital Management client reception continues to be outstanding and we are actively working on growing these relationships and adding additional business. We are looking for additional alliances to advance our business outside of the U.​S. and we continue to work to organically grow our offshore business. In the U.​S., we are on track to close the previously announced transactions with Fifth Third for their $​5 billion money market business, and Trustmark for their $​933 million money market, equity and fixed income business. Both are expected to close during the third quarter. We'​re looking forward for additional consolidation opportunities as well."

During the Q&​A, he responds to a question about the election, "​Well that there could be tactical changes [​with a new administration], but overall when we'​ve been fighting the Fed and the SEC on these kinds of businesses for four decades, or my whole career. It'​s hard for me to believe that any one political outcome or any one changing of the guard will eliminate what the regulators want to do, which is regulate these funds out of existence. So I think the threats will continue. Certainly a different SEC Chairman who was not totally fixated on money funds and was working stronger on all the other things that are in Dodd-​Frank that are required to be done, would be better for us in terms of the money fund business."

Finally, Donahue responds to a question on possible reform options, "They are all very troublesome.... So we just continue to fight on. It'​s really hard for us to try and make predictions about how SEC commissioners will vote.... [​W]​e remain confident that the proper public policy and good public policy will win out, which means that money market funds will continue. The proof of that is our continuing attitude towards making arrangements to take on other people'​s money funds and to continue to increase our market share. So I can'​t give a specific answer as to how I think the SEC will come out or whether it will flop over into FSOC or what will happen there, but as I said in answer to earlier question, it seems like it is our career to continue to fight for the survival of money funds."

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A press release entitled, "Federated Investors, Inc. Reports Second Quarter 2012 Earnings," says, "Federated Investors, Inc. (​NYSE: FII), one of the nation'​s largest investment managers, today reported earnings per diluted share (​EPS) of $​0.​39 for the quarter ended June 30, 2012 as compared to $​0.​41 for the same quarter last year. Net income was $​40.​4 million for Q2 2012 compared to $​42.​4 million for Q2 2011. Federated'​s total managed assets were $​355.​9 billion at June 30, 2012, up $​6.​5 billion or 2 percent from $​349.​4 billion at June 30, 2011 and down $​7.​7 billion or 2 percent from $​363.​6 billion reported at March 31, 2012.... Money market assets in both funds and separate accounts were $​265.​5 billion at June 30, 2012, down slightly from $​265.​7 billion at June 30, 2011 and down $​9.​2 billion or 3 percent from $​274.​7 billion at March 31, 2012. Money market mutual fund assets were $​238.​6 billion at June 30, 2012, up $​2.​5 billion or 1 percent from $​236.​1 billion at June 30, 2011 and down $​6.​6 billion or 3 percent from $​245.​2 billion at March 31, 2012."

It continues, "Revenue increased by $​6.​4 million or 3 percent due primarily to a decrease of $​9.​1 million in voluntary fee waivers related to certain money market funds in order for those funds to maintain positive or zero net yields and due to an increase in average fixed-​income assets. The reduction in fee waivers was primarily the result of improved yields available on securities held by money market funds.... Federated derived 52 percent of its revenue from equity and fixed-​income assets (​31 percent from equity assets and 21 percent from fixed-​income assets), 47 percent from money market assets and 1 percent from other products and services. Operating expenses increased $​9.​4 million or 6 percent primarily as a result of a $​4.​5 million increase in distribution expense related primarily to reduced fee waivers and increased compensation and related expense."

Federated'​s release tells us, "Revenue increased by $​1.​9 million or 1 percent primarily related to a decrease in the aforementioned voluntary fee waivers due mainly to improved yields available on securities held by money market funds. This increase was partially offset by lower average money market assets and a change in the mix of average equity assets. Operating expenses increased by $​3.​2 million or 2 percent. This increase was primarily related to an increase in compensation and related expense and intangible asset related expense."

It warns, "Fee waivers to maintain positive or zero net yields could vary significantly in the future as they are contingent on a number of variables including, but not limited to, changes in assets within the money market funds, available yields on instruments held by the money market funds, actions by the Federal Reserve, the U.​S. Department of the Treasury and other governmental entities, changes in expenses of the money market funds, changes in the mix of money market customer assets, Federated'​s willingness to continue the fee waivers and changes in the extent to which the impact of the waivers is shared by third parties."

Finally, the company adds, "Federated will host an earnings conference call at 9 a.​m. Eastern on July 27, 2012. Investors are invited to listen to Federated'​s earnings teleconference by calling 877-​407-​0782 (​domestic) or 201-​689-​8567 (​international) prior to the 9 a.​m. start time. The call may also be accessed in real time on the Internet via the About Federated section of FederatedInvestors.​com. A replay will be available after 12:​30 p.​m. and through Aug. 3, 2012 by calling 877-​660-​6853 (​domestic) or 201-​612-​7415 (​international) and entering codes 286 and 397419." Look for more coverage following the call or in Monday'​s "​News".

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Lobbying group PreserveMoneyMarketFunds.​Org issued a statement yesterday that included recent letters from New York, Ohio and Pennsylvania County associations opposing further money fund regulatory changes. The group'​s release says, "The SEC'​s push for structural changes to money market funds (​MMFs) continues -- but so does the outcry of opposition from those who rely on MMFs and will be harmed by the SEC'​s proposed changes. Recently, a number of county associations from across the country have spoken out via letters to the SEC." (​See the letters here from the New York State Association of Counties, County Treasurers Association of Ohio, and the County Commissioners Association of Pennsylvania.)

The New York letter states, "​The mission of the New York State Association of Counties is to represent, educate, advocate for, and serve member counties and the thousands of elected and appointed county officials who serve the public. To that end, NYSAC has been monitoring the Securities and Exchange Commission'​s proposal that would drastically change the structure of money market funds, and limit the investment options for counties. New York State'​s county governments are required to keep cash in accounts with a stable principal value. For over 40 years money market funds have filled this role in county governments' cash management plans by providing a safe and secure investment mechanism that offered historically higher yields than traditional bank savings accounts."

It adds, "Money market funds hold more than half of the short-​term debt -- about $​85 billion -- that state and local governments borrow to pay for public projects such as road and bridge construction, water and sewage treatment facilities, hospitals, and affordable housing. This source of financing allows counties to build, maintain, and improve vital infrastructure without requiring that taxpayers pay exorbitant interest rates for capital projects. The historical stable share price of money market funds has created a useful investment option for individuals, institutional investors, and state and local governments. NYSAC believes that forcing money market funds to change their $​1.​00 per-​share price and "​float" their net asset value (​NAV) could decrease the value, and therefore the investor demand for money market funds."

The Ohio letter explains, "​County governments in Ohio operate under legal constraints or other policies that prevent them from investing in instruments without a stable value. If money market funds are required to float with their NAVs, many counties in Ohio would be forced to use alternative funds that are less regulated, less secure, and less liquid. Having access to 100% of money invested in a money market funds when needed is another critical attribute. Holding back a portion of an investor'​s money would drive investment away from the funds. Either of these proposed changes could severely damage the ability of counties to use money market funds."

Pennsylvania'​s County group comments, "​In 2010, the SEC reinforced the regulations covering money market mutual funds. We believe that further regulations involving the adoption of a floating NAV, would cause many of our members to divest a significant percentage of their investments in these funds. Our members would then have to look at other products that, in turn, could be more susceptible to market conditions, more difficult to account for and manage, more likely to pose greater market risks, and more expensive, increasing the costs and fees associated with investing. To avoid these negative consequences, we believe that any money market fund reforms must not allow for a change in the fundamental stable net asset value feature."

PreserveMoneyMarketFunds.​org adds, "The message is clear and consistent from counties and other local government entities across the country. Structural changes to MMFs such as a floating NAV or redemption restrictions on assets would severely hamper cash management and financing at the local level. MMFs are working and playing a key role in our economy. Hopefully, the SEC is listening to the growing chorus of groups who rely on MMFs that the proposed changes are a bad idea."

In other news, The Wall Street Journal reports that "​U.​S. Money-​Market Funds Slash Lending to Euro-​Zone Banks in June - Fitch citing recent Fitch Ratings statistics. The article says, "U.​S. prime money-​market funds cut lending to euro-​zone banks to a record low in June as concerns about Europe'​s debt crisis ramped up, according to a Fitch Ratings report. These investors slashed the amount of euro-​zone bank debt they held by 33% from May, Fitch said Wednesday, marking a resumption of last year'​s dumping of assets from the troubled region. Money-​market funds have reduced their euro-​zone holdings by 80% since May 2011, but virtually all of the decline occurred last year."

The piece adds, "Euro-​zone bank debt makes up about 8% of the total holdings of the 10 largest U.​S. prime money-​market funds, or about $​49 billion, down from 30%, or $​230 billion, in May 2011. Much of that money shifted to Japanese banks, which at 11.​8% of holdings now make up a larger share of funds' assets than the euro zone for the first time." (​See also, Crane Data'​s July 13 News "​European Money Fund Holdings Drop Back to Near Record Lows in June".)

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S&​P recently published a study entitled, "California County And Local Government Investment Pool Managers Position Themselves For Growth, But At What Cost? which says, "Standard & Poor'​s Ratings Services' latest annual survey of California investment pool managers reveals that although pool participants see interest rate increases as the greatest portfolio risk, they are allowing their portfolio duration (​a measure of sensitivity to interest rate movement) to increase, thus making their investments more susceptible to that very risk. We interpret this to mean that investment pool managers see decent growth prospects and are seeking marginally higher investment returns rather than flight to liquidity."

The study explains, "California'​s ongoing budget and general fund cash deficits have underscored the importance of cash management at the local agency level throughout the state, in our view. School districts in particular, which depend considerably on state aid, have seen a growing portion of their state-​aid revenue deferred from one fiscal year to the next. These deferrals add to the challenge of cash management. Even when the state'​s budget is not distressed, a local government'​s cash outflows commonly exceed its inflows during certain periods of the year. To bridge these cash deficits, local agencies can, in the manner of states, use internal cash resources or borrow on a short-​term basis from the capital markets by issuing tax and revenue anticipation notes (​TRANs), many of which we rate. Although not a replacement for revenue lost because of state-​aid reductions or economic weakness, TRANs help local agencies manage relatively predictable mismatches between anticipated cash receipts and cash disbursements."

S&​P continues, "Local agencies in California frequently invest idle capital and operating funds and proceeds from TRAN issues in their respective local county investment pools (​LCIPs). Some local agencies and numerous LCIPs themselves invest in several statewide local government investment pools (​LGIPs). In either case, the statutory goal for the investing agencies or LCIPs is maintaining the safety and liquidity of their investments. In addition, with limited revenue raising flexibility in California, investments are an important source of income, albeit usually smaller (​frequently 5% or less of general fund revenue) than primary revenue (​such as property tax). During the past few years we'​ve seen investment incomes decline, consistent with the Federal Open Market Committee'​s continuation of low interest rates since December 2008, which in turn reduced the yields on short-​term Treasury holdings. In our ratings analysis for TRANs and long-​term debt issued by many of the counties and local agencies, we consider exposure to LCIPs and LGIPs as credit factors. This is because LCIPs hold and invest cash proceeds (​which are operating funds) on behalf of the local agencies and because many local agencies -- and all school districts – invest other idle operating and capital funds with their LCIPs."

The study adds, "We note that macroeconomic risks to California investment pools during the next year could include: Uncertainty regarding the EU'​s austerity measures, which could keep the markets depressed for the near term; The U.​S. presidential election, which has historically shown more favoritism to equity markets rather than to bond markets; and A lack of any emerging or growing sectors in the economy that could lead to any significant productivity growth, although that lack could keep the bond markets a safe haven."

In other news, consulting firm Treasury Strategies recently submitted a letter to the SEC'​s Mary Schapiro taking aim at a recent Moody'​s commentary. The letter says, "​We are pleased to submit for your review the enclosed letter to Moody'​s Investors Service. The letter is our rebuttal to the Moody'​s report, "​Weekly Credit Outlook: US Money Market Funds," which was published on July 2, 2012. Our letter presents a fact-​based and logical challenge to Moody'​s conclusions regarding the impact of additional regulations to Money Market Funds that are currently under consideration by the US Securities and Exchange Commission. Those regulations include: Capital Buffer, Floating NAV, and Redemption Restrictions. The gravity of these potential regulations and magnitude of their impact underlines the importance of presenting the facts accurately, in the proper context and without spin. We are compelled to distribute the enclosed letter to you as it is of material importance during your deliberations on additional Money Market Fund regulations."

Treasury Strategies' letter to Moody'​s Henry Shilling explains, "​In response to your comments regarding US Money Market Funds ... Treasury Strategies, Inc. (​TSI) would like to contribute the following information for your consideration.... As we have reflected upon your comments regarding the SEC'​s money market fund (​MMF) proposals, we believe it is necessary to consider the secondary effects of these proposals when discussing the credit impacts to investors and fund sponsors. We believe the impacts are negative to both fund investors and fund sponsors."

It adds, "Some specific points for consideration include: Imposing a capital buffer will have far more negative consequences to investors and fund sponsors: 1) by attracting more risk averse investors who are more likely to run at the first sign of trouble, and 2) in terms of pushing managers to take on more portfolio risk to compensate for the cost of the additional capital. Many more investors would leave MMFs under a floating NAV. This exit would greatly reduce the size of a fund and destroy the economies of scale that are crucial to the business. The report'​s view of sponsor support can be very misleading to readers. The study and the SEC Chairman'​s remarks both toss around numbers with neither substantiation nor context. Because the report does not name these "​problem" funds, a dispassionate and objective third-​party analysis is impossible."

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A press release entitled, "ICD'​s Transparency Plus 3.​0 Revolutionizes Exposure Analytics by Expanding to Include a Wide Range of Fixed Income Investments says, "Institutional Cash Distributors (​ICD) today announced the release of Transparency Plus 3.​0 (​T+ 3.​0), its latest exposure analytics application with powerful new institutional investment features and risk management capabilities that further aggregates investment decision-​control for corporate treasury."

The releases bullet points summarize, "ICD'​s award-​winning Transparency Plus expands to include separately managed accounts (​SMA'​s), short duration bond funds, money market funds, proprietary portfolios, bank accounts and time deposits; Transparency Plus 3.​0 is the only institutional investment analytics application to load fund holding reports on a weekly basis; Transparency Plus 3.​0 offers counterparty lending indicator metrics; and, Transparency Plus 3.​0 expanded analytic reporting includes the T+ Comprehensive Report, T+ Universal Investment Exposure Report and T+ Money Market Fund Guideline Actual Report."

ICD'​s Jeff Jellison, CEO North America, comments, "​This is the logical next important step for exposure analytics. Corporate treasury departments need to manage and monitor all of their investment positions in order to provide the level of risk management required in today'​s economic environment."

The release adds, "​Key to this release is the macro view T+ 3.​0 creates for investors and cash managers. The conversion of disparate financial data into usable intelligence has been a continuing focus of ICD'​s specialization in institutional investments and the risk management challenges that surround them.... ICD is unique in its market position and its internal capability to more rapidly capture fund holding and investment data."

Ed Baldry, ICD'​s CEO Europe noted, "ICD Tech has developed advanced proprietary methods for collecting, normalizing and loading investment data on a weekly basis. For products with weighted average maturity limits of as little as 60 days, weekly versus monthly fund-​loading time differentials are essential for generating superior investment intelligence." Transparency Plus 3.​0 streamlines the decision matrix for corporate treasury institutional investment and risk management.

Finally, ICD'​s Tory Hazard tells Crane Data, "We had multiple clients come to us and say they really wanted the ability to do exposure analytics across all of their short term investments, and Transparency Plus 3.​0 answers that for them. They can look at any number of direct exposures, whether it'​s their bank accounts, CDs, Time Deposits, whatever their positions are with the direct exposure, they'​re able to include that. They could even break it down to the equity level."

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With a second round of Money Market Reform proposals possibly imminent (​we expect the meeting for the vote to be announced Wednesday), Arnold & Porter'​s John Hawke has submitted yet another comment letter to the SEC on behalf of Federated Investors. Hawke'​s latest missive, which was just posted to the President'​s Working Group Report on Money Market Fund Reform, does the service of condensing the 178 or so comment letters that have been submitted since the Jan. 10, 2011 PWG deadline into a 51-​page summary. Hawke writes, "​We have reviewed the various letters, surveys, reports and other data collected in the Commission'​s public file for the 2010 Report of the President'​s Working Group: "​Money Market Fund Reform Options" (​PWG Report). As you know, the initial public comments addressed specific options for money market fund (​MMF) reform put forward in the PWG Report, including a "​floating" net asset value for MMFs. Later comment letters have addressed two additional options for restrictions on MMFs: imposing a capital requirement on MMFs; and imposing a "​holdback" or minimum balance requirement. In your recent Senate testimony and in earlier speeches, you expressed support for each of these three proposed restrictions on MMFs as a way to reduce MMFs "​susceptibility" to runs. We understand the Commission currently is considering a draft proposing release containing these three elements."

Hawke continues, "As you know, the Commission is required by statute to consider the impact of a proposed rule on efficiency, competition, and capital formation, and its failure to do so has resulted in several reversals of Commission rules by the D.​C. Circuit Court of Appeals, which has been highly critical of the Commission'​s failure to assess the economic impact of proposed new rules. The Commission has responded to these cases and to similar criticism from the Congress, the General Accountability Office, and the Commission'​s own Inspector General by developing internal guidance for economic analysis in rule proposals. That guidance requires, among other things, that an analysis of the "​likely economic consequences" of any proposed rule be "​substantially complete" even before a rule is proposed."

He says, "The depth and scope of data, surveys and other information from commenters in the PWG Report file gives the Commission a unique opportunity to conduct this analysis before moving forward with a rulemaking proposal on MMFs. We, therefore, submit the attached summary of the public comment file in an effort to assist the Commission in assessing the potential economic consequences of each of the three proposals."

Hawke explains, "In reviewing the public comment file, what is striking is the multitude of comments by users of MMFs who describe the essential role MMFs play across a range of cash management operations for businesses and public entities, as well as the essential role of MMFs as purchasers of corporate commercial paper and state and local government debt. While one might expect the fund industry to participate vigorously in the debate over potential new restrictions on MMFs and fund companies and the industry'​s trade association have done so here by providing substantial data, analyses and surveys -- the Commission also must give great weight to the fact that businesses, chambers of commerce, state and local governments and their associations across the country have written about the importance of MMFs in bringing efficiencies to their cash management operations and in substantially reducing their cost of funding. There is a consistent message from these users that they either will not use, or will sharply reduce their use of, MMFs if any of the three proposals are adopted, because the resulting product will no longer meet their investment needs. If that occurs, according to commenters, a shrunken MMF industry would result in increased cost of funding for businesses and governments and would be enormously costly for the economy. The public comment file also includes strong warnings that a flight of investors from MMFs to less regulated vehicles or to the largest banks would increase systemic risk and, therefore, bring about exactly the opposite result that proponents of the proposals desire."

He adds, "As described in the attached summary, there are a handful of letters in the comment file primarily from current or former bank regulators and academics -- supporting one or more of the three types of potential new restrictions on MMFs. To date, there is no data or economic analysis in the public file to support the view that any of the proposals would reduce MMF runs, and, indeed, there are some studies and reports suggesting that the proposals, if adopted, could actually precipitate runs. The benefits of the proposals, therefore, remain speculative, while the adverse economic consequences -- as articulated in the comments of MMF users -- could be devastating."

Hawke writes, "We, therefore, suggest that moving forward with a rule proposal, which itself would create substantial uncertainty in the markets at a time when we can ill afford it, is ill-​advised. At minimum, if there is, as reported, a staff draft release containing economic analysis in support of various proposals, that analysis should be publically vetted before a proposal is formally released. This is particularly important given the overwhelming evidence in the public file to date arguing against the proposals."

Finally, he says, "​We hope the attached summary is helpful. We also hope the Commissioners will take the time to read the studies, surveys, reports and other commentary in the comment file in full before considering further actions to impose restrictions on MMFs."

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Now we know where the convoluted idea for a 30-​day redemption "​holdback" came from. A paper entitled, "The Minimum Balance at Risk: A Proposal to Mitigate the Systemic Risks Posed by Money Market Funds," coauthored by Fed economists Patrick McCabe, Marco Cipriani, Michael Holscher, and Antoine Martin, was just posted on the Federal Reserve Bank of New York'​s website. A statement published yesterday, entitled, "New York Fed Releases Staff Report on Money Market Fund Reform," says, "The Federal Reserve Bank of New York today released a staff report describing how a proposal for money market mutual fund (​MMF) reform would make the financial system safer and more fair, reducing systemic risk and protecting small investors who do not redeem quickly from distressed funds."

The release explains, "The paper discusses a proposal to mitigate the vulnerability of MMFs to runs by introducing a "​minimum balance at risk" (​MBR) that that would provide a disincentive to withdraw funds from a troubled money fund. The MBR would be a small fraction of each shareholder'​s recent balances that would be set aside in the event that they withdrew from the fund. Most regular transactions in the fund would continue as before, but redemptions of the MBR would be delayed for thirty days. The delay would ensure that redeeming investors remain partially invested in the fund long enough to share in any imminent portfolio losses or costs arising from their redemptions."

The New York Fed'​s statement continues, "At present, investors in a troubled fund have a strong incentive to run because those that are first to the exit can get out with 100 cents on the dollar, leaving other investors in the same fund to bear any losses. The MBR proposal would substantially reduce the incentive to run and ensure more equitable distribution of any loss among investors in a fund. Under the proposal discussed in the paper, as long as an investor'​s balance exceeds the MBR, the rule would have no effect on transactions and no portion of any redemption would be delayed if the remaining shares exceed the minimum balance."

It adds, "Additionally, MBRs could strengthen market incentives for early market discipline for MMFs by clarifying that investors cannot quickly redeem all shares from a fund during a crisis. Investors would have strong incentives to identify potential problems well before any losses are realized. Furthermore, by discouraging investors from redeeming shares in a troubled MMF, the MBR would help the fund avoid the need for fire sales of assets to raise cash -- an effect that not only benefits the fund and its investors, but also reduces contagion risk throughout the system."

William Dudley, president of the New York Fed, comments, "Further reform of money funds is essential for our nation'​s financial stability. Proposals currently under consideration, that are consistent with the basic idea discussed in this staff report, would make the financial system much safer. I strongly endorse their adoption." The release adds, "​Mr. Dudley noted that small investors could be exempted from the requirement to maintain a minimum balance as they were less prone to withdraw their money at the first sign of trouble."

The full paper says in its Abstract, "This paper introduces a proposal for money market fund (​MMF) reform that could mitigate systemic risks arising from these funds by protecting shareholders, such as retail investors, who do not redeem quickly from distressed funds. Our proposal would require that a small fraction of each MMF investor'​s recent balances, called the "minimum balance at risk" (​MBR), be demarcated to absorb losses if the fund is liquidated. Most regular transactions in the fund would be unaffected, but redemptions of the MBR would be delayed for thirty days. A key feature of the proposal is that large redemptions would subordinate a portion of an investor'​s MBR, creating a disincentive to redeem if the fund is likely to have losses. In normal times, when the risk of MMF losses is remote, subordination would have little effect on incentives. We use empirical evidence, including new data on MMF losses from the U.​S. Treasury and the Securities and Exchange Commission, to calibrate an MBR rule that would reduce the vulnerability of MMFs to runs and protect investors who do not redeem quickly in crises."

The study'​s "Conclusion" states, "The MBR offers some important advantages over other proposals for reducing the vulnerability of MMFs to runs. Importantly, the MBR could allow MMFs to maintain features that are central to their attractiveness to investors, particularly their stable $​1 NAVs, their market-​based yields, and the immediate liquidity of the vast majorities of investors' balances. The MBR would not require raising the large sums that would be needed to create a meaningful capital buffer, so the MBR likely would be more feasible than a standalone capital option (​although a capital buffer could complement an MBR rule well). Moreover, the MBR rule creates a deterrent to redeeming in times of stress that cannot be provided by a floating NAV or a capital buffer. And unlike some proposals for conditional restrictions or fees on redemptions, an MBR rule would not set up incentives for preemptive runs. Indeed, the MBR likely would improve market discipline for MMFs by strengthening investors' incentives to monitor and respond to MMF risks when they first arise, rather than waiting to redeem until serious problems are imminent."

​

BlackRock, the fourth largest money fund manager in the world with $​235.​0 billion and the seventh largest money fund manager in the U.​S. with $​140.​5 billion (​according to Crane Data'​s Money Fund Intelligence XLS and MFI International), hosted its Second Quarter Earnings Call yesterday. While CEO Larry Fink normally addresses money funds and gets questions on the topic, he only mentioned the cash space once on the most recent call. Just over 35 minutes into the call, Fink says, "​Let me move on to regulatory. This uncertain regulatory environment and recent bank missteps in financial services will undoubtedly call for more regulation, and asset managers may be impacted. This is the new reality and BlackRock is trying to stay ahead of the curve in preparing for increased global regulation. Let me just discuss money market funds. Being in Washington yesterday, I believe we are going to see the SEC finally come out for comment period a proposal."

He continues, "I don'​t know what the proposal is, but I think the gridlock within the SEC may be broken. I may be premature in talking about it, but that is the kind of noise I heard in Washington. We have publicly acknowledged the need to further reduce the systemic risk in money market funds without undermining money market funds' source of value to investors and funding to the short term capital markets. We have maintained a constructive posture with the SEC and with the FSOC staff throughout this debate."

Fink adds, "[​On] SIFI designation, the Office of Financial Research is conducting a study of assets managers. We have encouraged them to try to be more transparent in their study. The study should be completed sometime in fall and then there is going to be a lengthy comment period. So at this moment I don'​t have any information on what that means for Blackrock or any other non-​bank organization and that is being reviewed with the Office of Financial Research. So at this time I can'​t give any more color on this. But we will learn at the same time everyone else learns when the official proposal is introduced by the FSOC."

In other news, the Financial Stability Oversight Council, or FSOC, released its 2012 Annual Report yesterday. It says, "​Stable wholesale short-​term funding markets are a critical component of a well-​functioning financial system, but if they suffer disruptions, these markets can rapidly spread shocks across financial institutions. The Council continues to be particularly focused on structural vulnerabilities in money market funds (​MMFs) and the tri-​party repo market, as follows."

The FSOC writes on page 11, "The Council continues to support the implementation of structural reforms to mitigate the run risk in MMFs.... [​T]​he SEC'​s 2010 reforms did not address -- and were not intended to address -- two core characteristics of MMFs that continue to contribute to their susceptibility to destabilizing runs. First, MMFs have no mechanism to absorb a sudden loss in the value of a portfolio security, without threatening the stable $​1.​00 NAV. Second, their continues to be a "​first mover advantage" in MMFs, which can lead investors to redeem at the first indication of any perceived threat to the value or liquidity of the MMF."

They continue, "SEC Chairman Schapiro recommended two alternative reforms to address these remaining structural fragilities. They are (​1) a mandatory floating NAV; and/​or (​2) a capital buffer to absorb losses, possibly combined with a redemption restriction to reduce the incentive to exit the fund. The Council supports this effort and recommends that the SEC publish structural reform options for public comment and ultimately adopt reforms that address MMFs' susceptibility to runs."

Finally, FSOC adds, "In addition, the OCC issued a proposed rulemaking in April 2012 that would partially align the requirements for short-​term bank common and collective investment funds (​STIFs) with the SEC'​s revisions to Rule 2a-​7 under the Investment Company Act. In an effort to impose comparable standards on comparable financial activities, the Council further recommends that, where applicable, its members align regulation of cash management vehicles similar to MMFs within their regulatory jurisdiction to limit the susceptibility of these vehicles to run risk." (​FSOC also addresses the "Tri-​Party Repo Market.")

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Fitch Ratings put out a press release entitled, "U.​S. Corporate Cash Investments Signal Ongoing Risk Aversion yesterday, saying, "U.​S. corporations continue to invest excess cash into shorter-​term and lower-​risk instruments, according to a new report by Fitch Ratings. This trend signals that risk aversion continues to be used as a buffer against market uncertainties in the longer term. Holdings of cash and other liquid assets at U.​S. industrial corporations rose to $​1.​7 trillion in March 2012, according to the revised statistics provided by the Federal Reserve, though this figure might have been even higher absent a change to the Fed'​s process for calculating these levels. By the end of the second quarter, cash and liquid assets held by nonfinancial companies reached approximately 11% of U.​S. GDP."

The release continues, "​Fitch examined consolidated financial statements filed in Q1 2012 for the top 10 U.​S. corporations ranked by their cash and cash-​equivalent positions. According to Fitch'​s analysis, the bulk of liquid corporate assets are invested in either cash and cash-​equivalent securities, such as short-​term bank deposits, money market funds, or conservative longer-​term investments, such as U.​S. Treasury and agency securities. Structured finance holdings, municipal debt, equity-​based investments and non-​U.​S. corporate securities collectively accounted for barely 10% of total liquid corporate holdings, highlighting the relatively risk averse nature of corporate portfolio investments."

It adds, "Fitch expects corporations will continue to hold high levels of cash, certainly until there is some resolution of the European financial crisis and clearer evidence that the U.​S. economy is stabilizing. Various U.​S. companies currently hold higher buffers of cash and liquid assets to guard against another potential decrease in the availability of capital, and have exercised caution with regard to expanding or acquiring new operations, given the uncertain economic outlook."

In other news, IMMFA, the London-​based Institutional Money Market Funds Association released a statement last week saying, "The recent decision by the ECB to lower the deposit rate from .​25% to zero has resulted in a significant reduction in yields in the EUR money markets, presenting challenges for managers of IMMFA EUR money market funds. As an industry, we have experienced similar conditions in the US market towards the end of 2008 when USD rates fell to very low levels. Some US and European USD funds decided to limit subscriptions to their USD funds at that time. In late 2011 when yields on core Eurozone government were negative, some EUR money market funds decided to restrict subscriptions to protect investors."

The statement continues, "Limiting subscriptions in funds in such challenging yield environments is one means of protecting the interests of existing shareholders in the fund. It is a mechanism used if an individual fund'​s investment advisor and Board of Directors deem it to be necessary. Fund managers monitor the markets daily and make decisions based upon what is best for shareholders in light of prevailing market conditions. When managers have decided to restrict subscriptions, there is no restriction on redemptions; shareholders are permitted to redeem from MMFs as normal."

Finally, the comment adds, "IMMFA money market funds continue to be an important and popular tool for investors seeking a conservative option for cash investments. IMMFA funds total EUR 522BN (​E, $ and L combined) in AUM as of 29 June 2012 and this is an increase of EUR 220BN or 73% since 30 June 2007 when the strains from the financial crisis first began to appear in global money markets. IMMFA managers have a strong track record of managing through the many challenging market environments since 2007 whilst at the same time implementing a series of positive changes including increased minimum liquidity levels, greater transparency for investors, and portfolio stress testing."

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Standard & Poor'​s published a CreditFAQ written by Andrew Paranthoiene, Francoise Nichols, and Emelyne Uchiyama entitled, "Implications Of Negative Yields For European Money Market Funds?" yesterday. It says, "European money market funds have been coping with the prospect of near zero or negative yields for most of 2012. That'​s especially true for a subset of those funds, the region'​s government liquidity funds, which invest in high credit quality "​safe haven" government debt. And following the European Central Bank'​s interest rate reductions effective last week -- the benchmark rate dropped to 0.​75% from 1% and the deposit facility interest rate went to 0.​00% from 0.​25% -- all of these funds and the eurozone'​s financial markets are moving into uncharted territory."

The piece explains, "European government money market funds were established by the largest money market fund providers mainly in 2007 and 2008 as a "​flight to quality" product for investors who were risk-​averse about the European banking system. These government liquidity products offer money market investors a diversified pool of high credit quality and safety by investing in the most liquid European government securities. However, yields for safe haven assets and those sought after by euro-​denominated government liquidity funds (​less than one-​year to maturity), like German and French six-​month bills, have been close or below 0.​00% since the beginning of the year."

S&​P continues, "​Last week we observed that German and French six-​month debt sold at negative yields. Even before the ECB lowered its deposit facility rate to 0.​00%, placing additional pressure on the money market industry, the prospect of negative yields for eurozone government liquidity funds was apparent. This is likely one of the main causes of the decrease in total assets of European government liquidity funds that Standard & Poor'​s rates. We find a 48% drop in assets so far in 2012."

It adds, "As a result of the 0.​00% deposit rate, Standard & Poor'​s Ratings Services believes that there is an increased likelihood that negative yields on individual money market investments in the European Economic and Monetary Union (​EMU or eurozone) may accumulate to produce a negative return to money market funds. This in turn would increase the likelihood of lower net asset values (​NAV) per share for euro-​denominated money market funds. Although money market fund yields are lagging official interest rates, persistently low to negative yields on money market funds may lead investors to redeem their shares, possibly placing additional strain on these funds. Such developments could be credit-​negative for our principal stability fund ratings (​PSFR) on these funds."

S&​P states, "If these conditions continue or possibly even worsen should the ECB lower rates further in September, fund providers may assess the viability of these products. If they decide to close these funds, it will further reduce the amount of investment choices available to investors. In recent days, European money market fund providers have taken practical steps to protect their funds from yield dilution. This is either through implementing "​soft closes," meaning that the funds are closed to subscriptions from external investors, while certain existing shareholders can continue to invest; or through "​hard closes," meaning no new investment by any type of shareholders. Closing a fund to subscriptions reduces the need to invest new money at lower or negative yields, which would further deteriorate a fund'​s overall yield. According to our analysis, money market fund closures have reached E79 billion out of a total euro-​denominated rated asset pool of E133 billion to date. Other euro-​denominated money market funds have taken a different view and remain open but cautious about evolving market conditions."

Finally, the piece comments, "Another option available to managers is reassessing their current investment mandate to possibile increase duration or venture into other asset classes. However, this option may have limited attractiveness for now given uncertainties in the eurozone. As securities in the portfolios mature, it is already becoming increasingly difficult for investment managers to find suitable investment opportunities in a negative yield environment."

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John Hawke of Arnold & Porter has penned another comment letter to the SEC and Chairman Mary Schapiro, which was posted to the President'​s Working Group Report on Money Market Fund Reform website late last week. Entitled, "Role of Federal Reserve in Supporting Short-​Term Credit Markets File No. 4-​619; Presidents Working Group on Money Market Funds, it says, "A recurrent theme raised by supporters of radical change to the regulation and structure of money market mutual funds (​MMFs) is that the Federal Reserve lent money to MMFs to bail them out during the Financial Crisis, that Congress in the Dodd-​Frank Act prohibited the Federal Reserve from ever doing so again, and therefore the continued existence of MMFs in their current form poses a grave financial risk to the world economy."

He explains, "The Federal Reserve did not lend to MMFs under the Asset-​Backed Commercial Paper MMF Liquidity Facility (​AMLF), it lent to banks, and it did so to address illiquidity in the commercial paper market, not to bailout MMFs. As discussed below, this is exactly the purpose for which the Federal Reserve was created in 1913. MMFs did not cause the recent financial crisis -- the crisis had been underway for 20 months before the Reserve Primary Fund "​broke a buck" in September 2008 -- but MMFs were not immune from its effects. The AMLF program was one small part of a large number of credit programs put in place by the Federal Reserve and Treasury Department to deal with illiquidity during the recent Financial Crisis."

Hawke writes, "As you no doubt are aware, the history of the United States has included many financial panics characterized by sharp contractions in lending and the availability of credit, accompanied by economic contraction in the form of increased unemployment and decreased output of goods and services.... The Federal Reserve Act of 1913 created the Federal Reserve System, including the Federal Reserve Banks and the Board of Governors of the Federal Reserve System. The purpose underlying the Federal Reserve Act of 1913, as stated by Congress, was "[​t]​o provide for the establishment of the Federal reserve banks, to furnish an elastic currency, to afford a means of rediscounting commercial paper, to establish a more effective supervision of banking in the United States, and for other purposes." Of the four stated Congressional purposes behind the Federal Reserve Act, one is specifically to provide liquidity to the commercial paper market, and that purpose was listed by Congress ahead of regulation of banks."

He adds, "​Sections 13 and 14 of the Federal Reserve Act ... contain the main provisions by which the Federal Reserve System provides liquidity to banks, through banks to the underlying short-​term credit markets, and in some instances directly to the short-​term credit markets. When the Federal Reserve extends credit, it does not provide a "​bail out". Instead, it lends on commercially appropriate terms against sound collateral. The Federal Reserve extends credit to protect the short-​term credit markets from seizing up, in order to protect the economy. Providing this short-​term credit is the purpose for which the Federal Reserve was created. It is the reason the Federal Reserve is sometimes referred to as "​the lender of last resort." The primary purpose and function of the Federal Reserve, the essential reason it was created by Congress, is to address financial panics by providing liquidity by lending into the short-​term credit markets, when no one else will."

Hawke explains, "​Similarly, during the recent Financial Crisis, there were a number of instances in particular credit markets becoming illiquid. These included the February 2008 freezing up of the auction rate municipal securities market, a tightening of the repo markets in 2007-​2008, and a general tightening and illiquidity in the market for securitized assets beginning in 2007. Indeed, as early as August 2007, in recognition of banks' unwillingness to lend to each other and the deterioration of conditions in the financial markets, the Federal Reserve began taking extraordinary steps to inject liquidity into the market. In December 2007, it launched the Term Auction Facility, the first of over a dozen special liquidity programs. In September 2008, during the Financial Crisis, the market for commercial paper (​including, in particular, asset backed commercial paper "​ABCP")) became illiquid. This made it difficult to holders of commercial paper, including banks, MMFs and other investors, to sell commercial paper, which in turn made investors unwilling to roll over existing commercial paper or purchase new issues of commercial paper. The Federal Reserve responded very quickly with the creation of the AMLF, by which banks were able to borrow from the Federal Reserve against the collateral of performing ABCP purchased by the banks from MMFs. The collateral for the Federal Reserve loans was high-​quality commercial paper, and the loans were all repaid with interest in full and on time at a profit to the Federal Reserve."

He adds, "The AMLF was one of the smaller and shorter-​lived financing programs of the Federal Reserve and Treasury during the Financial Crisis of 2007-​2009.... The AMLF balances represented less than 1% of the aggregate amount of the various emergency lending programs put in place by the federal government during the Financial Crisis. A larger lending facility, the Commercial Paper Funding Facility was put in place by the Federal Reserve in October 2008 to provide a liquidity backstop directly to commercial paper issuers, and the Money Market Investor Liquidity Facility was put in place for investors in money market instruments in October 2008 but was never called upon. These programs were terminated in 2009 and 2010."

Hawke'​s letter tells us, "​Sections 214, 1101, 1306 and 1501 of the Dodd Frank Act placed restrictions on government lending to insolvent institutions or foreign governments, 5 and Section 131 of the Emergency Economic Stabilization Act of 2008 precluded the Treasury Department from creating future MMF guarantee programs similar to its 2008 MMF guarantee facility. Sections 1101-​1109 of the Dodd Frank Act, however, which tightened somewhat the Federal Reserve'​s emergency lending authority, preserves the basic function and authority of the Federal Reserve System under Sections 13 and 14 of the Federal Reserve Act to provide liquidity to the financial markets. If needed tomorrow, the Federal Reserve could launch a program similar to the program it undertook to address the Penn Central crisis in 1970 or something very much like the AMLF (​the fact that asset backed commercial paper -- a subset of the overall commercial paper market has shrunk in size is irrelevant). Although the Federal Reserve retains the authority under the Federal Reserve Act to make future extensions of credit to provide liquidity in the commercial paper market, changes in 2010 to SEC rules governing MMFs liquidity requirements make it unlikely that MMFs would need to rely on that source of secondary market liquidity in the future."

He says, "The SEC'​s 2010 amendments to Rule 2a-​7 now require MMFs to hold massive amounts of short-​term liquid assets in their portfolios (​at least 10% overnight liquidity, 30% 7-​day liquidity, plus additional amounts based on an assessment of their shareholders' liquidity needs and plans, with current liquid assets of MMFs estimated to exceed $​1 trillion on $​2.​6 trillion in total assets). Moreover, MMFs currently hold very little ABCP, so it is unlikely that a facility similar to the AMLF will be needed in the future. A current example of an extraordinary short-​term liquidity facility being provided by the Federal Reserve is the extension of over a trillion dollars in short-​term dollar financing to the European banking system through the European Central Bank."

Hawke continues, "Our point is not to criticize the Federal Reserve for these programs, as many have done. Instead, in our view the Federal Reserve and Treasury did an extraordinary and highly effective job during the recent Financial Crisis to provide liquidity to various sectors of the economy. This was exactly what was needed, and this as precisely the role for which the Federal Reserve was created in 1913. The Federal Reserve and Treasury deserve praise, rather than criticism, for these extraordinary credit programs. Financial panics existed long before MMFs were invented. If the Federal Reserve and its supporters succeed in their efforts to do away with MMFs, financial panics will continue to occur. Whether they invest in MMFs or invest directly in commercial paper and other short-​term credit instruments, lenders and investors will continue to withhold new loans and cease to roll over existing credit in the face of a financial crisis. There will continue to be a "​flight to quality" in times of uncertainty. If MMFs no longer exist, the Federal Reserve will still be required, from time to time, to provide liquidity to short-​term credit markets to resolve a financial panic."

Finally, he writes to Schapiro, "In your testimony on June 28, 2012 to the Senate Banking Committee, you did not accept the use of the term "​shadow banks" for MMFs, noted that the Securities and Exchange Commission, rather than the federal banking agencies, is the appropriate regulator of MMFs, and stated that the Commission has taken strong steps through the 2010 amendments to Rule 2a-​7 to address the liquidity issues in MMFs and to strengthen and improve the program of regulation and supervision of MMFs. We agree. We disagree, however, with concluding that because the Federal Reserve in September 2008 provided liquidity through the AMLF to the commercial paper market, MMFs are inherently unstable, that MMFs make the short-​term credit markets less stable, that MMFs caused or worsened the Financial Crisis that began 20 months earlier and was brought to a head by the receiverships of two government sponsored enterprises, the forced sale of Merrill Lynch, and the bankruptcy of Lehman Brothers before the Reserve Primary Fund "​broke a buck" and the bailout of AIG at about the same time. In uncertain times there is always a market flight to quality, a contraction of private credit, and a tightening of liquidity in the short-​term credit markets. This will occur regardless of whether MMFs exist and regardless of the structure of MMFs. The purpose of the Federal Reserve is to provide liquidity to the short-​term credit markets in uncertain times. It served that role for 60 years prior to the creation of MMFs. Changing the fundamental structure of MMFs or doing away with them entirely will not lessen the need for the Federal Reserve to serve as the lender of last resort to provide liquidity to the short-​term credit markets."

​

The latest batch of Money Fund Portfolio Holdings show that funds reduced their European exposure substantially in June as outflows hit the sector. J.​P. Morgan Securities' "Update on prime money fund holdings for June 2012" comments, "Eurozone bank exposures declined by $​47bn in June according to our estimates, driven by reductions in unsecured CP/​CD and repo by $​29bn and $​19bn, respectively. Overall changes to ABCP and repo were minimal. June'​s decline in Eurozone bank holdings brings the total slightly below that of 2011 year-​end and marks a $​58bn decline from February after a LTRO induced ramp up in Eurozone bank holdings from December 2011 to February 2012. Despite the decline, French bank holdings of $​49bn remain $​17bn above 2011 year-​end levels." (​Note: Crane Data released its June 30 Portfolio Holdings and updated its new Money Fund Portfolio Laboratory yesterday, but our "​Pivot" Tables & Reports are due out later this morning.)

JPM'​s Alex Roever, Teresa Ho and Chong Sin write, "​Reductions to Eurozone banks in June were primarily driven by declines in Dutch and French bank unsecured CP/​CD holdings and German bank repo holdings. Reductions in Dutch and French bank CP/​CD holdings were isolated to a couple of large prime fund complexes while reductions in German bank repo holdings were fairly broad-​based. Reductions in Eurozone unsecured paper likely reflects a return to a more conservative stance many MMFs are taking with ongoing anxiety surrounding the Eurozone and its banks. Although Dutch banks like Rabobank are still among the highest rated large banks in the world, the search for quality has pushed its yields to rich levels relative to those of its peers. Some of this cash has been rolled over to Swedish and Japanese bank unsecured CP/​CDs that are of similar credit quality to that of Rabobank without being part of the Eurozone."

Deutsche Bank Economist William Prophet writes in his latest comment, "He'​s Just Not That Into You," "​We'​ve been wondering for some time now whether U.​S. money funds would once again look to pare back their exposure to European banks. There was of course a radical reduction in European lending during 2011. But things stabilized late last year and believe it or not, the trend has generally been in a holding pattern ever since. But we'​re beginning to see signs that this is changing. In particular, there was a meaningful decline in both secured and unsecured lending to European banks during the month of June with loans to Europe down some 35% over the past two months (​among the funds in our universe)."

He adds, "And unlike last year when French banks felt the brunt of this re-​allocation, the decline in European lending over the past two months has been relatively broad-​based.... The good news is that we'​re not seeing a meaningful increase in borrowing rates. In other words, even though lending volumes are down, what is getting done is getting done at yesterday'​s level. And so in that respect, the trend in LIBOR has indeed been a fairly accurate indicator of actual bank borrowing costs."

Both strategist'​s commentaries also discuss the recent cut in European rates. Roever comments, "On July 5, the ECB slashed the deposit facility rate from 25bp to zero leading to several fund management companies to shut their EUR denominated MMFs to new money. (​We note that the highest quality EUR-​denominated MMFs (​more on this below) represent only about 10% of the E1tn Euro area domiciled MMF AUM.) Closures to new money was an understandable move as some funds cannot invest at negative yields, and even those that can may not want to eat into the returns earned by the rest of the portfolio."

The JPM piece adds, "According to Crane Data'​s latest available holdings data for European MMFs (​most of which are IMMFA MMFs) as of May 2012, EUR-​denominated MMFs held about 15% of assets (​about E15bn) in repo, all of them in repo backed by government or government-​related collateral. Without further detail, we don'​t know the composition of the collateral but given the high quality nature of these MMFs, we suspect the collateral is limited to core European sovereign debt and highly rated government agencies and supra sovereigns."

Finally, Deutsche'​s Prophet says in his "Final Thoughts," "On a related topic, even though the ECB recently voted to reduce its bank deposit rate to 0%, we do not think the Fed will follow suit. In other words, we do not think the Fed will be cutting its IOER rate anytime soon. Indeed, eliminating interest on excess reserves would most likely put the U.​S. money fund industry out of business. And while certain U.​S. regulators would presumably like nothing more, we'​re fairly confident that this is not one of the goals of the FOMC."

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On Tuesday, we wrote about the recently released "2012 AFP Liquidity Survey (​see Crane Data'​s July 10 News "​Cash and Bank Deposits Still King In 2012 AFP Liquidity Survey"). Today, we excerpt from the Survey'​s section on Money Market Fund Reform. AFP says, "Even though no formal proposal had been released at the time of this report, stakeholders and market observers have speculated that the Securities and Exchange Commission (​SEC) and the Federal Reserve will soon consider possible money market fund reforms. The Fed has indicated a desire to implement reforms in MMFs through the SEC, principally to mitigate risk from the Fed'​s role as a backstop or financial guarantor of last resort, as occurred during the 2008 financial crisis. There is wide speculation about what such reform proposals would entail."

AFP explains, "Possible proposals include one of three potential scenarios (​or a combination): 1) a floating net asset value (​NAV) on money market funds in their investment mix; 2) a holdback provision on redemptions; and 3) capital requirements placed on fund sponsors to provide additional liquidity support. Indications from the SEC in late June of 2012 (​when this report was being written) suggest that scenario #​1 or #​3 above is the most likely reform."

The survey continues, "​Perhaps the most controversial of the three potential proposals is the floating NAV. From the perspective of many treasurers, a floating NAV would undermine the safety of principal that has made money market funds an attractive investment vehicle. Should this proposal be enacted, many organizations would need to revamp their investment policies and look for alternative investments that offer comparable safety, liquidity and yield. If the demand for MMFs wanes as a result, a floating NAV would also change market dynamics for debt issuers that supply the securities to the money market fund companies (​e.​g., commercial paper)."

AFP tells us, "Seventy-​seven percent of survey respondents expect their organizations would be less willing to invest in MMFs and/​or would reduce/​eliminate their holdings of MMFs currently in their short-​term investment portfolio in response to a floating NAV. Large organizations, those that are publicly held and net investors are most likely to make changes in their MMF investments in response to reform."

They comment, "Possible policy decisions organizations may make in the wake of a move to a floating NAV include: Fourteen percent of organizations would not alter their investment strategy with MMFs until the NAV falls below $​1. Seven percent would maintain current holdings but would not make additional investments in MMFs. Twenty-​three percent would stop making investments and would reduce current holdings. Thirty-​three percent would stop investing in MMFs as they eliminate all current holdings. Only 23 percent of respondents indicate the potential reform would have no bearing on their organizations' willingness to invest in MMF."

AFP says, "The goal of the holdback provision (​the second scenario above) is to support an orderly liquidation should there be a run on funds. Under the holdback provision, fund companies would subject redemptions by investors to a ten percent holdback that would be paid approximately 30 days later. The holdback proposal, however, could violate the liquidity principle under which treasury departments manage their organizations' short-​term investment portfolios."

Finally, they add, "Many financial professionals indicate that if this proposal were enacted, their treasury departments would stop investing in money market funds in one form or another. Forty-​three percent of financial professionals report that their organizations would go as far as eliminating money market funds from their short-​term investment holdings altogether. In fact, a significant percentage would either reduce them (​30 percent) or liquidate them entirely (​43 percent). Moreover, just over half of financial professionals at privately held organizations say their organizations would eliminate all their holdings, a response with major implications for financial markets."

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With trillions of "​cash" investments hanging in the balance, a battle has begun in Congress over extending unlimited FDIC insurance in noninterest bearing transaction accounts, with the Investment Company Institute (​ICI) declaring opposition and the Independent Community Bankers of America (​ICBA) arguing for an extension. Yesterday, the ICI commented in a section on "Unlimited Insurance for Noninterest-​Bearing Transaction Accounts" in its "Written Testimony for House Hearing: The Impact of Dodd-​Frank on Customers, Credit, and Job Creators." General Counsel and Executive Vice President of Legg Mason & Co. Thomas Lemke said, "​In the Dodd-​Frank Act, Congress granted circumscribed authority for the FDIC to provide unlimited deposit insurance only to specified accounts and only for a two-​year period. Congress should reject calls to extend this program beyond its statutory expiration date, because the program has the potential to dislocate markets and increase systemic risk in times of market stress by creating an unlimited taxpayer-​supported backstop for noninterest-​bearing transaction accounts."

ICI'​s comments explain, "Section 343 of the Dodd-​Frank Act requires the FDIC to provide unlimited insurance for "​noninterest-​bearing transaction accounts" for two years starting December 31, 2010. This provision is intended to give depositors of insured depository institutions, most notably corporations and other institutional investors, additional assurance that their balances in noninterest-​bearing transaction accounts will be safe as the financial crisis wanes. As with any program that insures customer funds, however, the insurance coverage authorized by Section 343 poses potential costs to taxpayers and raises the risk of dislocations elsewhere in the financial system. Presumably in recognition of these potential costs and risks, Congress granted circumscribed authority, requiring the FDIC to provide unlimited insurance for only specified accounts, and for only a two-​year period."

They continue, "We understand that some are calling for Congress to extend this unlimited insurance program beyond its statutory expiration date. ICI strongly opposes any such extension. We view the program as having the potential to dislocate markets and increase systemic risk in times of market stress by creating an unlimited taxpayer-​supported backstop for these transaction accounts. To understand ICI'​s concerns, it is helpful first to understand the economic role of deposit insurance and how deposit insurance can influence the actions of banks and depositors, as well as investors in the broader markets. Banks have limited ability to liquidate assets quickly to meet large, unexpected withdrawals. Deposit insurance reduces the probability of bank runs by eliminating the potential advantage enjoyed by those depositors who are first to withdraw their money from a bank. Greater stability of bank deposits provides greater stability in the credit creation process and the overall economy."

ICI adds, "Despite its demonstrated benefits, however, deposit insurance also entails risks for the financial system. For example, insurance reduces the incentives for insured depositors to monitor the creditworthiness of banks, which in turn creates a moral hazard that can encourage banks to take additional risks, knowing that depositors will not withdraw their deposits if the bank'​s financial condition deteriorates. In addition, deposit insurance can cause other systemic risks for financial markets by increasing the propensity for investors to sell off assets -- such as stocks, bonds, mutual fund shares, and other securities -- and move the proceeds into insured deposits. As the FDIC has previously observed, this behavior can produce or exacerbate broader market dislocations during periods of financial stress."

Finally, the Insitute'​s comment says, "Indeed, recent experience suggests that such activity would worsen any future financial crisis and reduce credit available to businesses, state and local governments, and other borrowers. Depository institutions would be unlikely, and in many cases unable, to buy the assets investors were selling. Instead of risking a recurrence, every effort should be made to avoid such a series of events. Historically, the risks posed by deposit insurance programs have been mitigated by capping the amount of a depositor'​s account that is insured (​currently $​250,​000). In the case of the insurance authorized by Section 343 of the Dodd-​Frank Act, the statutory limits on the types of accounts covered and the December 31, 2012 termination date should serve to reduce the possible negative effects of the program. With the stability of the U.​S. financial system at stake, the importance of these limits cannot be overemphasized. Congress therefore should resist any efforts to vitiate them."

The Independent Community Bankers of America recently wrote to Senators Reid and McConnell, "The undersigned bankers' banks, which serve more than 5,​000 community banks nationwide, urge Congress to extend the FDIC'​s transaction account guarantee ("​TAG") insurance well before its scheduled expiration at year-​end 2012. We are deeply concerned about the impact on community bank liquidity and business lending should FDIC TAG insurance be allowed to lapse at year-​end. In the current economic environment, an abrupt contraction in liquidity would pose an unacceptable risk to credit availability and the economic recovery. We ask that the Congress extend the FDIC TAG program at the earliest possible opportunity. Banks fully pay for this FDIC insurance coverage through their insurance premiums and no taxpayer money is used."

The ICBA letter continues, "TAG provides full insurance coverage for non-​interest bearing transaction accounts used by businesses of all sizes, municipalities, hospitals and other non-​profit entities for payroll and other recurring expenses. TAG was enacted during the financial and economic crisis to protect depositors and to prevent a sudden withdrawal of deposits that would dislocate the banking system. According to the latest FDIC figures, some $​200 billion is deposited in community bank TAG accounts where it supports local loans to small businesses and consumers. The average community bank under $​10 billion in assets has $​23 million in TAG-​insured deposits. A lapse in TAG would very likely shift these deposits out of community banks in favor of the largest banks. In fact, bank regulators are already instructing community banks to prepare written "​contingency funding plans" to show how they would replace deposits in the event that TAG lapses. The FDIC apparently also believes that these funds will leave our community banks."

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The Association for Financial Professionals, an organization which represents corporate treasurers, released it 2012 AFP Liquidity Survey this morning. The latest version of the annual study contains one of the most comprehensive looks at large corporations' short-​term investment policies and practices, and we excerpt a number of the findings of interest to the money market mutual fund investment community below. AFP'​s Introduction says, "​Short-​term cash management has never been more in a state of flux than in recent years. Events during the past four years that have had an impact on organizations' cash positions are still fresh in the minds of many financial professionals and continue to influence how they manage their cash. Companies -- not just those operating within the U.​S. but also those operating globally -- continue to hold high levels of cash. In an extremely low-​return, flat-​yield environment, it is no wonder safety and liquidity remain the top two primary investment objectives for most companies, with yield being a distant third. Recent research from the Association of Financial Professionals reveals that most companies expect their cash balances to continue to grow primarily through increased operating cash flows. In addition, many organizations anticipate their international cash balances to grow faster than their U.​S. balances."

The Liquidity Survey'​s Key Findings include: "Forty-​one percent of survey respondents report that their organizations held greater cash balances during the first quarter of 2012 than in the first quarter of 2011.... Fifty-​one percent of short-​term investment balances are maintained in bank deposits, an increase of nine percentage points from the 42 percent reported in the 2011 survey and the highest share reported since AFP began conducting the Liquidity Survey. As recently as the 2006 survey, the average bank-​deposit allocation was 23 percent. Organizations invest in an average of 2.​4 vehicles for their cash and short-​term investment balances, a figure that has not changed from that reported in the 2010 or 2011 surveys. Seventy-​four percent of all cash balances are maintained in banks, money market funds and Treasury securities. Three out of five survey respondents do not expect their organizations will reduce the amount of short-​term investment balances maintained in non-​interest bearing bank accounts after the expiration of unlimited FDIC insurance (​currently scheduled for the end of 2012)."

The Key Findings state about money fund regulations, "In light of possible SEC rule changes involving money market funds (​MMFs): Seventy-​seven percent of organizations would be less willing to invest in MMFs and/​or would reduce/​eliminate their holdings of MMFs currently in their short-​term investment portfolio as a result of allowing NAVs to float. Eighty percent of organizations would be less willing to invest in MMFs and/​or would reduce/​eliminate their holdings of MMFs in their short-​term investment portfolio as a result of being unable to fully liquidate MMF holdings immediately (​i.​e., holdback provisions). Sixty-​six percent of organizations would be less willing to invest in MMFs and/​or would reduce/​eliminate their holdings of MMFs in their short-​term investment portfolio should fund companies have to raise sufficient capital (​e.​g., through fees)."

AFP'​s latest survey, which was sponsored by RBS, explains, "Financial professionals generally expect current trends in their organizations' level of cash balances to continue, with a larger share of survey respondents indicating their organizations are likely to see their cash balances increase over the next year rather than decrease. Nearly all organizations permit the use of bank deposits as vehicles for short-​term investments. In addition, 68 percent of organizations permit investment in Treasury bills, while more than half of organizations allow the use of "​pure" Treasury money market funds (​MMFs, allowed by 56 percent of organizations). Commercial paper (​45 percent) and prime (​diversified) MMFs (​44 percent) are two other commonly permitted vehicles.... Still, organizations are shifting away from MMFs: MMFs account for only 19 percent of organizations' short-​term investment portfolios, compared to 30 percent in 2011. However, large organizations with over $​1 billion in revenues continue to allocate more of their short-​term investments to money markets than do smaller organizations."

It adds, "With more of their portfolio in bank deposits, organizations are relying increasingly on bank instruments for their cash and short-​term investments. The most commonly used bank products are non-​interest bearing accounts and time deposits; 58 percent of financial professionals report their organizations use non-​interest bearing accounts while 53 percent report using time deposits. Structured certificates and products are less commonly used vehicles, with fewer than one in five organizations using each. A majority of financial professionals do not expect significant changes to their organizations' strategies for short-​term investments in bank accounts when (​if) unlimited FDIC insurance is phased out at the end of 2012. However, two in five respondents do indicate their organizations may diversify their holdings by reducing short term investment in non-​interest bearing accounts. This figure rises to nearly half of net investor and publicly owned companies, representing significant potential withdrawals from banks. The most likely destination for the cash held in non-​interest bearing bank accounts would be prime MMFs, Treasury-​based MMFs, Treasury securities and/​or agency bonds."

The Survey also comments on "Portals," "Twenty-​nine percent of organizations use an electronic, multi-​family trading portal to execute at least a portion of their short-​term investment transactions. Large organizations and those that are publicly held are much more likely than smaller and privately held ones to use a multi-​family trading portal.... While organizations can use electronic trading portals to trade a number of investment vehicles, they do so primarily to trade prime MMFs (​cited by 69 percent of respondents) and Treasury MMFs (​57 percent). Just over one in five organizations that use an electronic trading portal do so to manage bank time deposits. Thirteen percent use portals for direct investment in Treasury/​government securities and seven percent use them for transactions involving holdings of commercial paper."

AFP explains, "When selecting money market funds, 60 percent of financial professionals cite fund ratings as a primary consideration in their organizations' decision-​making. Counterparty risk is the second most commonly cited factor (​53 percent), followed by the fund'​s sponsorship status as part of a bank relationship (​51 percent) as well as yield (​51 percent).... Interestingly, more than half of financial professionals rate yield as a primary driver in money market fund selection, even though only two percent of respondents indicate yield is the primary objective for their organizations' overall short term investment portfolios. Financial professionals whose organizations have annual revenues less than $​1 billion are more likely than those from larger ones to indicate yield as one of the most influential factors for money market fund selection.... A greater share of respondents from organizations with at least $​1 billion in revenue indicate their organizations prioritize diversification of underlying instruments, counterparty risk of underlying investments, and fund ratings in their selection process." (​Look for excerpts from the AFP Survey'​s section on MMF Reform in coming days.)

Finally, the survey concludes, "As companies look ahead and consider their investment options beyond the end of the year when unlimited FDIC insurance on non-​interest bearing accounts is set to expire, many will have to make some critical decisions about their short-​term investment allocation mix. To what extent will organizations re-​allocate their short term investment portfolio from bank accounts into other investment vehicles? And if they do move this cash out of banks, where would these balances flow to? The most obvious destinations, based on recent history, are Treasuries and "​pure" Treasury money market funds. But the possibility of MMFs losing their attractiveness as a result of speculated SEC rule changes may slow any move back into MMFs."

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The July issue of Crane Data'​s Money Fund Intelligence was e-​mailed to subscribers Monday morning, along with our June 30, 2012 monthly performance data and rankings, our Money Fund Intelligence XLS monthly spreadsheet, our Money Fund Wisdom database query website and our Crane Index money fund averages series. (​Our monthly Money Fund Portfolio Holdings with 6/​30/​12 data will be distributed on the 8th business day, July 12.) The new edition of MFI features the articles: "Go Time: SEC Proposals Pending? Fed'​s Backup," which discusses what and whether money fund reform proposals will be seen soon; "Pittsburgh MFS Excerpts; Donahue Myths Keynote," which excerpts from Federated Investors President & CEO Chris Donahue'​s recent keynote at our Money Fund Symposium; and, "Worldwide MF Update; Dunn Kelley Going Global," which reviews recent global developments and quotes Invesco'​s Karen Dunn Kelley'​s Symposium speech.

Our lead piece says, "​Summer vacation can'​t come soon enough for fund industry participants, regulators and journalists, all of whom have grown weary of the seemingly endless battle over potential money market fund regulatory changes. The fight not only continues, but continues to escalate, as Senators, Fed officials, professors and treasurers all attempt to put their two cents in. Reports say that SEC Commissioners have been given 30 days (​starting June 26) to review a 337-​page reform proposal that could be released (​if it has the votes) late this month, and banking regulators have also stepped up their rhetoric."

In lieu of a fund Profile this month, we excerpt from our recent Money Fund Symposium. Our piece says, "​Just over two weeks ago in Pittsburgh, we hosted our 4th annual Crane'​s Money Fund Symposium. This year'​s event attracted 420 money fund managers and money market professionals, and featured discussions heavily laden with regulatory, rate and risk content. We excerpt from the keynote address below and from several other sessions elsewhere in this month'​s MFI. (​Note that the recordings and Powerpoints are available to MFI subscribers via our Content center.)

The third feature piece reviews the Investment Company Institute'​s latest "​Worldwide Mutual Fund Assets and Flows", which Crane Data uses to tabulate a ranking of worldwide money market fund markets. We also review Friday'​s story about Euro money funds closing temporarily due to rates being cut to zero. (​See our "​Link of the Day".) Finally, we quote from Invesco'​s Karen Dunn Kelley, who presented at our Symposium on "Going Global: Money Funds Worldwide."

The July MFI also contains monthly News, Indexes, top rankings and extensive performance tables. E-​mail info@​cranedata.​us to request the latest issue. Subscriptions to Money Fund Intelligence are $​500 a year and include web access to archived issues and fund "​profiles". Additional users are $​250 and bulk pricing and "​site licenses" are available. Crane Data'​s other products include: Money Fund Intelligence XLS ($​1K/​yr), MFI Daily ($​2K/​yr), Money Fund Wisdom ($​4K/​yr), MFI International ($​2K/​yr), and Brokerage Sweep Intelligence ($​1K/​yr).

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As we mentioned yesterday, the posts keep coming on the SEC'​s "​President'​s Working Group Report on Money Market Fund Reform (​Request for Comment)" website. The latest is from Columbia University Law Professor Jeffrey Gordon, who recently submitted his oddball ideas to the Senate Banking Committee'​s "​Perspectives on Money Market Mutual Fund Reform" and who recently appeared at the AEI'​s "​Do money market funds create systemic risk?" webinar. Gordon writes, "I have studied the money market fund problem since the fall of 2008. `​This has resulted in two detailed comment letters to the SEC, one in September 2009 and the other in August 2011, both of which are attached to this submission. A co-​author and I have also conducted empirical analysis of the relative run risks of floating vs. fixed net asset value ("​NAV") funds, based on a "​natural experiment" involving off-​shore dollar-​denominated money market funds during "​Lehman week" in September 2008. These self-​regulated funds generally follow the SEC rules on portfolio composition but are available in both fixed and floating NAV. We find that the fixed/​floating distinction does not explain the variation in the run rate across funds; rather, the relative risk of the fund, proxied by yield prior to Lehman week, is the crucial fund-​level explanatory variable. (​We are in the process of finishing a draft of this research, which should be public shortly.)"

He continues, "​For the record, none of my research in this area has been supported by any party other than Columbia Law School as part of the customary research funding it provides to faculty members. Based on this cumulative work, my views are the following: Money Market Mutual Funds ("​MMFs") are like banks, except they have no provision for bearing loss and internalize none of the systemic risk costs of their activities. MMFs present a unique "​two-​sided" run problem that makes them an unstable source of credit. Since most MMF credit is now extended to banks, this makes MMFs a significant vector for financial crisis. These problems can be addressed through requiring MMF investors to acquire bundles of Class A/​Class B shares, in which fixed NAV is preserved for the Class A shares."

Gordon writes, "First, a money market mutual fund is like a bank in that it holds a portfolio of risky assets (​non-​U.​S. Treasury), yet, unlike a bank, holds no capital nor any other first-​loss protection. Its NAV will fall below $​1 upon the default of virtually any appreciable portfolio holding, unless the sponsor decides to step in to cover the loss. The fact that sponsors frequently have provided such support provides no assurance that a particular sponsor(​s) will have sufficient resources or willingness to provide support in the midst of a financial crisis. The Reserve Primary Fund illustrates the problem of sponsor incapacity for a large fund, and at only $​60 billion, this fund was hardly the largest."

He adds, "Second, the lack of capital or any other first-​loss protection means that MMFs are exposed to a "​two-​sided run problem." One side of the run problem is well understood: MMF fund investors who perceive a risk of default will want to be first in line at the withdrawal window. If other investors perceive a similar risk, the best strategy is to withdraw first and ask questions later, producing a run. The second side of the run problem is less well-​understood but equally important. MMFs provide short term finance to financial institutions (​especially banks) as well as to non-​financial commercial paper users. Precisely because they have no first loss protection against default of portfolio securities, MMFs will be extremely sensitive to the risk of default by the parties they finance. This means, for example, if a bank runs into financial distress, MMFs will either shorten the maturity of the obligations from this counterparty or refuse to rollover the obligations altogether. In other words, because of the first run problem, the MMF depositor run risk, MMFs in turn create a run problem for parties that depend on MMF financing. Because of the threat that depositors will run on the MMFs, the MMFs may run on their counterparties."

Gordon tells the Senate panel, "​Third, the two-​sided run problem has very important (​negative) macro implications. A little background is necessary. The main function of MMFs currently is to provide diversified portfolios of credit-​screened short-​term claims on financial firms to cash-​holding institutions seeking safety and liquidity. For example, an operating company with large cash reserves could deposit the funds in a bank or itself assemble a portfolio of money market instruments. An MMF is better than these two alternatives, because a diversified portfolio of financial firm claims is safer than a deposit in a single bank (​given the cap on deposit insurance), and the MMF can achieve scale economies in producing diversified, screened portfolios of such claims. In the evolution of MMFs from the 1980s until the present, the largest users have become institutional, and the mix of MMF assets has moved overwhelmingly to claims on financial firms (​and related financing entities).... Two implications follow. First, MMFs have become a major vector for financial sector distress. Because the credit-​worthiness of financial firms is highly correlated, if a single financial firm defaults on its money market issuances, MMFs will take this as a signal of the likelihood of other defaults in the financial sector and will thus run on many other financial firms by refusing to roll over credit."

He explains, "Here is the policy-​relevant structural point: A significant fraction of this particular vicious circle is the direct result of the fragility of the MMFs themselves as presently designed. To repeat: The MMFs have no capacity to bear default on any portfolio security. Thus, much of the wholesale short term funding mechanism dances to the MMFs' short-​rigged tune. Fourth, it is possible to design an MMF that will preserve the benefits currently associated with MMFs but reduces some of the systemic risk and other negative effects. My August 2011 comment letter extensively presents such a proposal. The main feature is this: Institutions that invest in MMFs buy two classes of MMF stock, Class A and Class B, as a Class A/​Class B bundle, in a ratio of roughly 95% to 5%. Class A shares carry fixed NAV and thus can be used transactionally without tax or accounting consequences; Class B may float in value and may bear loss. An investor can withdraw Class A shares at will. Class B shares can be withdrawn only upon a 7-​day (​or 30-​day) lag, a holdback.... Other details are spelled out in the comment letter."

Gordon posits, "​There are three advantages. First, this arrangement significantly enhances MMF stability, which will reduce not only their systemic risk potential but will also change MMF behavior in periods of financial stress, like right now. Because MMFs will have first loss protection, their own funding decisions need not be on hair trigger, with positive effects throughout the short term funding process. This may encourage bank extensions of credit to non-​financial borrowers. Second, the structure of the Class A/​Class B bundle protects not only against portfolio defaults but also against run risk. That is because a Class A holder also owns Class B. Class A holders will therefore be far less likely to run, because a run that leads the MMF to sell assets at fire-​sale values and thus to break the buck will be costly for the holder'​s Class B shares. Before a run was "​free" to the holder; now there will be potential costs."

Finally, he writes, "Third, the cost of this arrangement is borne by the MMF users, not the sponsors or the taxpayers. This proposal will not drive the MMF industry out of business. The fact is, institutional MMF investors have no better alternative. Short term bond funds, of course, have floating NAV. Bank deposits carry risk if uninsured. This proposal merely requires institutional MMF investors to internalize the cost of systemic stability for MMFs rather than relying on implicit guarantees from the rest of the financial sector and the U.​S. government (​and the taxpayers)."

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Recent news reports have indicated that the five SEC Commissioners have been given 30 days to analyze a 337-​page Money Market Fund Reform Proposal (​or proposals) to decide whether to vote to allow the draft to become public, the letter posting barrage continues unabated on the SEC'​s President'​s Working Group Report on Money Market Fund Reform (​Request for Comment) website. (​See Crane Data'​s June 27 News, "​Bloomberg: Money Fund Reform Proposal Presented to Commissioners".) We excerpt from several recent additions below. These include two additions from the prolific Melanie Fein of Fein Law Offices, including materials and presentation from the American Enterprise Institute'​s recent event -- "Money Market Funds, Systemic Risk and the Dodd-​Frank Act and "Do Money Market Funds Create Systemic Risk?" Recent postings also include another comment from the U.​S. Chamber of Commerce citing a `​study by Georgetown University Professor James Angel, "​Money Market Mutual Fund "​Reform": The Danger of Acting Now" (click here for a link to the paper) and a letter from the Utah Association of Counties.

Fein'​s "Money Market Funds, Systemic Risk and the Dodd-​Frank Act" study states, "This paper was prepared for a symposium sponsored by the American Enterprise Institute (​AEI) entitled "​Do Money Market Funds Create Systemic Risk?" The answer to the question is "​no" for the reasons that follow.... Ironically, the risk-​averse features of MMFs have attracted recent criticism by Federal Reserve officials and a handful of academic economists who have said MMFs are "​subject to runs," a source of "​systemic risk," and part of the "​shadow banking system." This criticism stems from events during the financial crisis of 2007-​2008 when the housing bubble imploded, major financial institutions failed, and investors lost confidence that the Fed had the ability to avert a total collapse of the financial system."

She explains, "Fed officials have created a narrative about the crisis that casts blame on MMFs for destabilizing the financial system and causing or exacerbating the financial turmoil. In furtherance of its narrative, which downplays the role of banks, the Fed has urged the SEC to adopt regulatory changes that would alter the defining features of MMFs that make them so agile and efficient. Industry experts have said that the Fed'​s proposals would make it impossible for MMFs to operate as they do now and bring about the demise of the industry. If the SEC does not adopt the Fed'​s proposals, reports are that the Fed will seek to exercise direct regulatory authority over them through the Financial Stability Oversight Council ("​FSOC")."

Fein adds, "This paper argues that, contrary to assertions by the Fed, MMFs pose no systemic risk to the financial stability of the United States and require no supervision by the Fed. This paper shows that MMFs did not cause the financial crisis, are not subject to runs, and are not part of the "​shadow banking system." To the contrary, this paper shows that MMFs are subject to more stringent regulation than applies to banking organizations, have a record of safety far superior to that of banks, and that the Fed'​s proposals to subject MMFs to bank-​like regulation would increase, not decrease, systemic risk. Moreover, despite suggestions otherwise, the Dodd-​Frank Act provides no legal basis for the Fed to supervise MMFs. MMFs are comprehensively regulated by the SEC and nothing in the Dodd-​Frank Act suggests that any change in their regulation is needed. Congress did not intend MMFs to be treated as SIFIs supervised by the Fed and nothing in the language of the Act requires or permits them to be so treated."

Fein'​s other posting says, "As is clear from my papers, I believe that MMFs play an essential role in the U.​S. financial system. It is unfathomable to me why anyone would want to eliminate a financial product that affords investors more safety of principal, more liquidity, more transparency, greater diversification, efficiency, convenience, and a market rate of return, than any other product in the financial system. One need only look at the regulation of MMFs to see that they are not the type of entity that creates systemic risk. They are regulated under the Investment Company Act of 1940, the Investment Advisers Act of 1940, the Securities Act of 1933, and the Securities Exchange Act of 1934."

The Chamber'​s latest letter explains, "​The U.​S. Chamber of Commerce, the world'​s largest business federation representing the interests of more than three million businesses and organizations of every size, sector, and region, believes that short-​term financing and cash management are critical for businesses to operate and expand in a global marketplace. As the Securities and Exchange Commission continues to contemplate additional changes to money market mutual fund regulation, the Chamber would like to draw your attention to a study by Georgetown University Professor James Angel, Money Market Mutual Fund "​Reform": The Danger of Acting Now, that demonstrates the potential adverse consequences of imposing unwarranted MMMF regulation."

They add, "The Angel Report shows that now is not the time to engage in further MMMF regulation because additional regulations could: increase costs in a low yield environment that could drive many MMMFs out of business; increase borrowing costs, which could impede capital formation and cash management for businesses; increase borrowing costs and restrict cash management for state and local governments; and concentrate and increase the threat of systemic risk."

Finally, the Utah comment letter states, "The Utah Association of Counties appreciates the opportunity to comment on the President'​s Working Group on Financial Markets Report on Money Market Fund Reform Options (​PWG Report). The Utah Association of Counties is a non-​partisan, non-​profit that represents all 29 counties in the State of Utah. The Utah Association of Counties is concerned with the report option identified that money market mutual funds abandon their stable $​1.​00 net asset value and adopt a floating net asset value instead. This change would likely have a negative impact to county government by adversely affecting an important source ofdirect financing and cash management for county government."

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Yesterday, Moody'​s Investors Service released a brief entitled, "US Money Market Fund Proposals Are Credit Positive for Investors; Negative for Sponsors," which says, "According to remarks made last Thursday by Mary Schapiro, chairman of the US Securities and Exchange Commission (​SEC) at a US House Oversight panel, an internal draft proposal designed to reduce money market funds' (​MMFs) systemic risk has been circulated for review by SEC commissioners. The proposal requires MMFs to choose from two options, both of which have been debated for several years. The first option requires MMFs to set aside capital to protect against unexpected credit events and to limit investors' ability to redeem their entire investment at times of market distress. The second option requires MMFs to value their shares on the basis of a floating net asset value (​NAV). Both regulatory proposals, which SEC commissioners must review within 30 days or so, are credit negative for MMF sponsors and credit positive for MMFs and their investors."

The company'​s "Weekly Credit Outlook" explains, "The negative effect on sponsors would have a greater effect on independent firms with limited capital and those whose assets under management are concentrated in money market funds, such as Federated (​not rated), and, to a more limited extent, Vanguard (​not rated). However, better capitalized sponsors and/​or sponsors with large diversified product platforms, such as FMR LLC (​A2 negative), JP Morgan Chase Bank, N.​A. (​Aa3 stable; C/​a3 stable), and Blackrock, Inc. (​A1 stable), which are among the largest sponsors of money funds, would be better positioned to manage the changes. MMFs' liquidity/​run risk would diminish and exposure to credit and/​or interest rate risks would be limited, all of which are credit positives for the funds. But the additional constraints on MMFs that reduce investors' risk will likely lower their returns. The options would have far reaching implications for MMF sponsors, investors and the funds themselves."

Finally, Moody'​s latest brief comment adds, "According to our research, at least 201 US MMFs received some form of sponsor support between 1980 and 2011. By accounting for gains and losses on a regular basis, as is the case with other mutual funds, investors may be less inclined to redeem their shares in a destabilizing fashion, a credit positive for MMF investors. However, the elimination of the stable NAV in favor of the floating NAV for MMFs may result in a less attractive liquidity product offering for investors because of tax and accounting complications for institutional investors who, in the aggregate, account for about 64% of industry assets. Consequently, we would also expect industry assets to decline from the current $​2.​5 trillion in the event either proposal was to be put in place."

In other news, Federated'​s Debbie Cunningham writes in the company'​s latest "Month in Cash: Forewarned is forearmed," "​As expected, Moody'​s Investors Service last month completed its review of major global banks in the U.​S., U.​K., Germany, France and Switzerland, downgrading all of them from one to three notches on a long-​term basis. The announcement, while clearly significant, did not meet with any real resistance or reaction from the marketplace, mainly because the moves had been priced into the markets long before. Moody'​s announced the review in February, and in the four months since, the markets had plenty of time to adjust to the implications of a potential downgrade. The downgrades haven'​t affected money markets much, either. The banks Moody'​s downgraded to second-​tier issuers are still rated as first-​tier institutions by Standard & Poor'​s and Fitch Ratings and, as a result, can still be used in money funds in accordance with SEC Rule 2a-​7. That'​s not to say that the money markets haven'​t adjusted by reducing exposure to and shortening maturities within these institutions to account for the possibility that S&​P or Fitch might review their ratings. For the time being, however, the impact of Moody'​s downgrade has been minimal."

She adds, "For the money market world, [​The Fed'​s Operation] Twist'​s extension represented a rare case in which increased monetary policy stimulus didn'​t hurt and, on the margins, actually helped. The sale of shorter securities in effect has put a floor beneath repo and Treasury rates, helping keep repo rates elevated while making Treasuries relatively more attractive compared with government agencies. Agency securities are fine; it'​s just that with Treasuries having the benefit of this Twist-​induced support, it makes sense to allocate more money in that direction than may have been the case otherwise. This is particularly welcome given that in the fourth quarter of 2011, money markets regularly faced overnight repo rates of one or two basis points and negative rates for Treasuries."

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On Friday in a speech entitled, "Our Financial Structures -- Are They Prepared for Financial Instability? in Amsterdam, new money fund industry nemesis Eric Rosengren, President of the Federal Reserve Bank of Boston, proposed yet another half-​baked idea for monitoring money fund risk. This time Rosengren focused on stress-​testing banks affiliated with money fund sponsors. He says, "Since the severe financial stresses of 2008, a variety of actions have been taken to strengthen the financial infrastructure and make banks more resilient in the face of adverse shocks. While many banks have improved their capital and liquidity positions since 2008, we still see in the headlines of newspapers around the world that financial stability remains very much an issue.... Today I want to highlight an area where remedial action is still required. My goal is to focus more attention on financial structures that by design or reality reduce or avoid capital charges.... Such structures are vulnerable to stresses that can have destabilizing effects on financial markets and the broader economy.... I will touch on two specific areas that merit consideration -- money market mutual funds sponsored by banking organizations, and broker-​dealer financing."

He explains, "I will discuss the possibility of using stress tests to illuminate the impact of various scenarios on fund sponsors, many of which are banks or financial institutions. My primary focus will be on prime money market mutual funds, with approximately $​1.​41 trillion in total assets as of May 31. Prime funds invest in a variety of securities that carry more credit risk than traditional U.​S. Treasury securities. Money market mutual funds allow investors to potentially earn a higher return on short-​term investments in part because -- unlike banks -- money market mutual funds are not required to hold capital. As a result, they often pay a competitive rate relative to bank deposits, and they provide investors many features similar to traditional bank deposits -- for example, immediate availability of funds as well as a fixed net asset value that does not fluctuate when the value of assets held by the money fund changes."

Rosengren continues, "So money market mutual funds provide investors with an investment vehicle with features like bank deposits -- but the funds do not hold capital. The problem is that a financial intermediary -- which has no capital, but takes credit risk, and provides under normal circumstances immediately available funds at a fixed net asset value -- may be inviting trouble. Such a fund can be susceptible if the credit risk of the assets it invests in were to rise, causing investors to become concerned about the fund'​s ability to sell its assets, meet redemption demands, and maintain a stable net asset value. Consequently, the implicit expectation of a bank-​deposit-​like investment can unravel, and the incentives to redeem could be strong."

He shows some charts of the asset swings from Prime and into Government money funds in 2008, and says, "While the funds may remain in the same fund family with this shift, investors who do not exit from the prime money market mutual fund could be financially impacted, and the prime fund might need to engage in a fire sale of assets to meet investor demands. Furthermore, firms counting on money market mutual funds to provide funding (​for example by buying their debt -- their commercial paper) can suddenly find that the primary purchasers of their paper are no longer active in the market."

He adds, "Our concerns should be amplified by the fact that many prime funds are sponsored by depository institutions or their affiliates.... Just under half the assets are held in funds sponsored by an asset manager not affiliated with a depository institution. But domestic (​U.​S.) bank holding companies, foreign bank holding companies, and savings and loan holding companies (​in other words companies affiliated with depository institutions) combined serve as the sponsoring organizations for a bit more than half the prime fund assets, and more than half of the number of funds."

Rosengren also opines, "While SEC regulations restrict the credit risk and maturity risk of prime money market mutual fund investments, these funds nonetheless can and do invest in risky assets. An example is provided by the number and value of Dexia obligations held by money market mutual funds at the end of 2010, less than one year before the Belgian and French governments needed to bail out the bank. As Figure 3 shows, a large number of money market mutual funds with various types of sponsors held Dexia paper at the beginning of the year in which Dexia failed. However, funds sponsored by banks or bank affiliates were over-​weighted relative to funds sponsored by asset management firms not affiliated with a bank, both in the number of funds invested in Dexia and the value of Dexia assets."

He says, "As recent studies have highlighted, it is quite common for money market mutual funds that have impaired assets to obtain support from their sponsors. Whether this is a cash infusion or a purchase at face value of an impaired asset, this support can represent draws on capital at times when the sponsoring organization is facing other capital pressures. Figure 4 shows support-​related losses by fund sponsors, using data provided by Moody'​s and broken down by sponsor type."

Rosengren explains, "While most of the losses were during stressful times, even during non-​stressful times there are some losses. Figure 5 sums the losses recognized over the five-​year period of 2007 to 2011. The degree of sponsor support is substantial. Support has been quite large and particularly prevalent for prime money market mutual funds which have depository institution or depository institution affiliated sponsors. Over this period, Moody'​s reports almost $​9 billion in losses associated with money market mutual funds by depository institution or depository institution affiliated sponsors."

He tells us, "The SEC has been working on reform proposals that would provide several measures to reduce the risk of stresses during times of financial market crisis and provide some capital support. I am very supportive of the current push within the SEC for additional reforms, which have the potential of mitigating many of the concerns I am sharing today. As the primary regulator of money funds, the SEC is in a position to adopt rules that would address the vulnerabilities of those funds more comprehensively, effectively, and efficiently than other approaches. However, at this time it is unclear what the final proposal will be, or whether the SEC'​s final proposal will be adopted."

Then, Rosengren threatens, "In the absence of such reforms for all money market mutual funds, an alternative for funds with depository institution or depository institution affiliated sponsors would be to include likely money market mutual fund support in the sponsor'​s stress tests. Based on the historical experience of their money market funds, the historical experience of similar funds, and their money market funds' exposures, sponsors could calculate the likely capital support needed from the organization in a stress scenario."

He says, "Again, this is an admittedly partial approach, in the absence of more comprehensive reforms that I hope will occur. But this approach would at least make more banking organizations more resilient (​it would not be just money market mutual fund structures that would need capital -- any financial structure that broke down during stress would need more capital) but it would also make clearer to money market mutual fund investors that banks had capital that could support funds during stressful periods. It would thus make clear that money market mutual funds with well capitalized sponsors are likely to be less risky than those that do not have well capitalized sponsors."

Finally, Rosengren adds, "Similarly, other financial products that circumvent standard capital requirements -- such as non 2a-​7 "​money market like" funds, stable value wrap products, and asset-​backed commercial paper -- could lead investors to expect that the sponsor holds capital for the support that these products could need in times of stress. While some firms are likely to argue they would not provide support for so-​called capital efficient products, the high frequency of support of money market mutual funds and other off-​balance-​sheet items during the crisis makes such claims dubious. In fact, this support might be encouraged by regulators during a crisis, in order to avoid broader problems of financial instability."

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