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U.​S. Treasury Secretary Timothy Geithner sent a letter Thursday afternoon to members of the `​Financial Stability Oversight Council, or FSOC regarding "Necessary Money Market Fund Reforms. A Treasury announcement of the letter says, "In advance of tomorrow'​s meeting of the Financial Stability Oversight Council (​Council), Secretary Geithner today sent a letter to the members of the Council regarding recent developments in the effort to reform the money market fund industry and address the threats those funds can pose to the stability of the financial system."

Geithner writes, "Last month, the Securities and Exchange Commission (​SEC) announced that it would not proceed with a vote to solicit public comment on potential structural reforms of money market funds (​MMFs). This comes after a long and concerted effort by the SEC to develop reform options. Further reforms to the MMF industry are essential for financial stability. MMFs are a significant source of short-​term funding for businesses, financial institutions, and governments. The funds provide an important cash-​management vehicle for both institutional and retail investors. However, the financial crisis of 2007–​2008 demonstrated that MMFs are susceptible to runs and can be a source of financial instability with serious implications for broader financial markets and the economy. In the days after Lehman Brothers failed and the Reserve Primary Fund, a $​62 billion prime MMF, "​broke the buck," investors redeemed more than $​300 billion from prime MMFs. Commercial paper markets shut down for even the highest quality issuers. Only Treasury'​s guarantee of more than $​3 trillion of MMF shares, a series of liquidity programs by the Federal Reserve, and support from many fund sponsors stopped the run and helped MMFs meet their shareholders' redemption requests in a timely manner."

He continues, "The SEC took important steps in 2010 to improve the resilience of MMFs by amending Investment Company Act Rule 2a-​7 to strengthen the liquidity, credit-​quality, maturity, and disclosure requirements of MMFs. But the effort toward reform should not stop there. The 2010 reforms did not attempt to address two core characteristics of MMFs that leave them susceptible to destabilizing runs: (​1) the lack of explicit loss-​absorption capacity in the event of a drop in the value of a portfolio security and (​2) the "​first-​mover advantage" that provides an incentive for investors to redeem their shares at the first indication of any perceived threat to the fund’​s value or liquidity."

Geithner tells the FSOC, "Both the President'​s Working Group on Financial Markets and the Financial Stability Oversight Council (​Council) have consistently called for the SEC to pursue additional reforms to address structural vulnerabilities in MMFs, including unanimous recommendations in the Council'​s 2011 and 2012 annual reports. The Dodd-​Frank Wall Street Reform and Consumer Protection Act (​Dodd-​Frank Act) gives the Council both the responsibility and the authority to take action to address risks to financial stability if an agency fails to do so. Accordingly, I would like the Council to consider taking a series of additional steps to address this challenge."

He explains, "As its Chairperson, I urge the Council to use its authority under section 120 of the Dodd-​Frank Act to recommend that the SEC proceed with MMF reform. To do so, the Council should issue for public comment a set of options for reform to support the recommendations in its annual reports. The Council would consider the comments and provide a final recommendation to the SEC, which, pursuant to the Dodd-​Frank Act, would be required to adopt the recommended standards or explain in writing to the Council why it had failed to act. I have asked staff to begin drafting a formal recommendation immediately and am hopeful that the Council will consider that recommendation at its November meeting."

Geithner adds, "The proposed recommendation should include the two reform alternatives put forward by Chairman Schapiro, request comment on a third option as outlined below, and seek input on other alternatives that might be as effective in addressing MMFs' structural vulnerabilities. Option one would entail floating the net asset values (​NAVs) of MMFs by removing the special exemption that allows them to utilize amortized-​cost accounting and rounding to maintain stable NAVs. Instead, MMFs would be required to use mark-​to-​market valuation to set share prices, like other mutual funds. This would allow the value of investors' shares to track more closely the values of the underlying instruments held by MMFs and eliminate the significance of share price variation in the future."

He says, "Option two would require MMFs to hold a capital buffer of adequate size (​likely less than 1 percent) to absorb fluctuations in the value of their holdings that are currently addressed by rounding of the NAV. The buffer could be coupled with a "​minimum balance at risk" requirement, whereby each shareholder would have a minimum account balance of at least 3 percent of that shareholder'​s maximum balance over the previous 30 days. Redemptions of the minimum balance would be delayed for 30 days, and amounts held back would be the first to absorb any losses by the fund in excess of its capital buffer. This would complement the capital buffer by adding loss-​absorption capacity and directly counteract the first-​mover advantage that exacerbates the current structure'​s vulnerability to runs."

Geithner writes, "Option three would entail imposing capital and enhanced liquidity standards, potentially coupled with liquidity fees or temporary "​gates" on redemptions that may be imposed as an alternative to a minimum balance at risk requirement. We should also be open to alternative approaches that satisfy the critical objectives of reducing the structural vulnerabilities inherent in MMFs and mitigating the risk of runs. We should use this opportunity to seek informed perspectives on the extent to which any mix of the specific reforms described above or other reforms would achieve the same level of protection for investors and the broader economy. The Council should engage with key stakeholders as part of this overall process."

He tells FSOC, "The proposal should take into account the concern expressed that reform of MMFs may result in outflows from MMFs to less-​regulated parts of the cash-​management industry. While investors should welcome enhanced protections in MMFs, experience tells us that we cannot ignore the potential for capital, in times of relative stability, to flow to less-​regulated sectors with fewer protections. Our objective should be to propose reforms to MMFs that protect the stability of MMFs without creating a competitive advantage for unregulated cash-​management products."

Geithner continues, "The SEC, by virtue of its institutional expertise and statutory authority, is best positioned to implement reforms to address the risks that MMFs present to the economy. However, while we pursue this path, the Council and its members should, in parallel, take active steps in the event the SEC is unwilling to act in a timely and effective manner. Under Title I of the Dodd-​Frank Act, the Council has the authority and the duty to designate any nonbank financial company that could pose a threat to U.​S. financial stability. The Council should closely evaluate the MMF industry to identify firms that meet this standard. Designating MMFs or their sponsors or investment advisers would subject those firms to supervision by the Federal Reserve and would give the Federal Reserve broad authority to impose enhanced prudential standards, potentially including the options discussed above. Alternatively, the Council'​s authority to designate systemically important payment, clearing, or settlement activities under Title VIII of the Dodd-​Frank Act could enable the application of heightened risk-​management standards on an industry-​wide basis."

He writes, "Other Council member agencies have the authority to take action to address certain of the risks posed by MMFs and similar cash-​management products. For example, the bank regulatory agencies should evaluate their authorities to impose capital surcharges on regulated entities that sponsor MMFs, or restrict financial institutions' ability to sponsor, borrow from, invest in, and provide credit to MMFs that do not have structural protections. As currently conducted, such activities can pose risks to financial institutions' safety and soundness in a variety of ways, including the potential for MMFs to curtail funding for financial firms abruptly in times of market stress and the implicit support provided by firms that sponsor MMFs. Additionally, the potentially destabilizing role of MMFs in the tri-​party repo market should be carefully assessed as part of the ongoing efforts to improve the safety, soundness, and resiliency of that market."

Geithner concludes, "​I urge the members of the Council to accelerate their evaluation of these alternatives. The members of the Council should move ahead to consider how best to give effect to these alternative paths as they consider public comments on reform options for the SEC. Without further reform of MMFs, our financial system will remain vulnerable to runs and instability, which are harmful for retail and institutional investors, businesses that need a reliable source of funding, the MMF industry, and the financial system as a whole. We will seek broad input from the full range of stakeholders on how best to design further reforms. Four years after the instability of MMFs contributed to the worst financial crisis since the Great Depression, with the failure of the SEC to act, the Council should now move forward with the tools provided by Congress."

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On Monday, U.​S. Securities & Exchange Commissioner Daniel M. Gallagher spoke at a SIFMA conference in Charlotte on "SEC Priorities in Perspective." Gallagher was one of the three Commissioners who declined to release Chairman Mary Schapiro'​s money market reform proposals, saying, "​After careful consideration, we determined that the changes the Chairman advocated were not supported by the requisite data and analysis, were unlikely to be effective in achieving their primary purpose, and would impose significant costs on issuers and investors while potentially introducing new risks into the nation’​s financial system." He said in his most recent speech (​which addresses money funds later in the talk), "I would like to talk today about regulatory distraction. By that, I mean a state of affairs in which a regulatory body is so inundated with external mandates that it risks losing focus of its core responsibilities. Given the mandates flowing from Congress, in particular those in the massive, 2319 page Dodd-​Frank legislation, this is a condition that we at the Commission must be very careful to avoid."

Gallagher commented, "​As the newest Commissioner at the SEC -- I started just over ten months ago, I knew I was coming back to the agency during an intensely regulatory and reactive period, given the Dodd-​Frank mandates, the response to the Madoff and Stanford Ponzi schemes, and the reaction to allegations of policy failures leading up to the crisis. Indeed, I was on the Staff before and during the crisis, and later during the negotiation of what eventually became Dodd-​Frank, so this was no surprise. I assumed I would be faced with two major tasks - evaluating and voting on regulations responsive to the financial crisis, and working to ensure that the Commission maintains a clear focus on its core responsibilities. To be sure, we are busy working on many of these activities, but the balance is not what you might have expected it to be."

He continued, "Dodd-​Frank was enacted to, among other things "​promote the financial stability of the United States by improving accountability and transparency in the financial system, to end "​too big to fail," and to protect the American taxpayer by ending bailouts." These are all extremely laudable goals. However, the statute'​s goals and its mandates are often unrelated."

Gallagher explained, "All-​told, Dodd-​Frank contains approximately 400 specific mandates to be implemented by agency rulemaking. A conservative estimate assigns almost 100 Dodd-​Frank mandates to the SEC for implementation by rule. Many of those have statutory deadlines. The SEC has adopted final rules implementing nearly a third of those statutory mandates. So while the SEC, like other financial sector agencies, will be busy implementing Dodd-​Frank for a long time to come, it is equally true that one immediate effect of Dodd-​Frank was to increase dramatically both the volume and pace of SEC rulemaking. It is not an exaggeration to say that the Commission is handling ten times the normal rulemaking volume.... The pace is unrelenting, and the substance is critically important to the U.​S. capital markets. We need to get a lot done fast – no question about it – but it'​s even more important that we get it right."

He added on NRSROs, "Given that the Commission has been analyzing the removal of rating agency references since former Chairman Cox and the Commission proposed removing them in 2008, I hope the staff will put forward a recommendation soon on the two most significant SEC rules embedded with such references - the so-​called net capital rule, and the money market fund rule. Action on these matters would not only satisfy a Dodd-​Frank congressional mandate, but it would be a long-​delayed and much needed step towards addressing a core problem infecting the U.​S. financial markets and regulatory system. More than any other action the Commission has taken since Congress took bold action to give the SEC formal oversight authority over credit rating agencies, fulfillment of the 939A mandate, if done properly, would serve to protect investors and markets alike from the failures of the credit rating agency industry."

Gallagher says on money funds, "At the same time, it is important that we recognize that there are areas that are crisis-​related, but are not addressed or even referenced in Dodd-​Frank. They nevertheless warrant Commission time and resources – perhaps on a considerably more pressing basis than certain of the Dodd-​Frank mandates. The number one issue at the SEC that falls into that bucket is – still today – money market fund reform. Believe it or not, money markets funds, despite being called by some the third rail of systemic risk, and despite featuring prominently in the financial crisis, were not addressed in 2319 pages of financial crisis legislation. And now this, as most of you have probably seen, has become a highly contentious issue at the Commission. Despite recent headlines, I hope and expect that the Commission will make a decision on appropriate reforms in this area soon after our economists have conducted an analysis of the key issues Commissioners Aguilar, Paredes, and I have raised. Acting without the benefit of such an analysis - in the context of a $​2.​5 trillion industry critical to investors, municipalities, and other issuers - would, quite frankly, be irresponsible."

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Late last week, the Fox Business Network interviewed Federal Reserve Bank of Boston President Eric Rosengren, and the discussion included several minutes on money market funds. (​The money fund-​related comments start at 4:​40 minutes on the video.) Fox Senior Washington Correspondent Peter Barnes said to Rosengren, "I do want to get to this money market fund issue. You'​ve been very concerned about the health of money market funds, which have held a lot of European bank debt, for example, short-​term funding from them. You'​ve been critical of the industry. But the funds, if you look at the composition of their holdings, have been reducing their positions in Europe. They'​ve been hedging more. What'​s your assessment of the money market mutual funds? What'​s your assessment of their health right now, of the risks to them right now?"

Rosengren answered, "​I think they have changed their portfolios and some of the risks I was concerned about six months ago or a year ago in terms of their European exposure they have brought down the risk in those exposures, which I think is a very positive sign. There'​s still a structural issue that has to be addressed. The money market funds are agreeing to provide a dollar for every dollar you put in. But they don'​t hold any capital and they do take risks. So during times of stress, that structure is going to come under stress as well. So I still think there are structural things that have to be done to the industry. But we'​ll have to see if the SEC is able to do that."

Barnes continued, "​So far it has not, which has led to some speculation that the Financial Stability Oversight Council, the FSOC, which includes the SEC, Chairman Bernanke, the Federal Reserve, and other regulators. If they don'​t see something out of the SEC, and all the regulators agree that they'​d like to see something out of the SEC, there'​s been some speculation that the FSOC might declare money market systemically significant institutions, and thus subject to additional regulation. Do you think that'​s a good idea?

Rosengren replied, "The current structure of money market funds poses a financial stability issue. We need to reduce that financial stability issue. No one wants to repeat the kind of experience that we had in 2008. I think we'​ll have to see what the best way to make sure that those financial stability concerns are appropriately addressed. FSOC may be one direction to go, but I think there are other directions as well. And I'​m still hopeful that the SEC may be able to take further action."

In other news, an announcement entitled, "Next Meeting of the Financial Stability Oversight Council (​FSOC) says "​​Secretary Geithner will chair the next regularly scheduled meeting of the Financial Stability Oversight Council on Friday, September 28 in closed session at Treasury." There is no official word on whether money market funds will be a main item on the agenda.

The FSOC'​s description says, "Created by the Dodd-​Frank Wall Street Reform and Consumer Protection Action, the Council provides comprehensive monitoring to ensure the stability of our nation'​s financial system. The Council is charged with identifying threats to the financial stability of the United States; promoting market discipline; and responding to emerging risks to the stability of the United States financial system. The Council consists of 10 voting members and five nonvoting members and brings together the expertise of federal financial regulators, state regulators, and an insurance expert appointed by the President. More information about the Council is available at www.​fsoc.​gov."

Finally, note that many "​offshore" money market fund providers are in Monaco this week for Europe'​s biggest corporate treasury show, the 21st annual International Cash and Treasury Management conference, which runs Sept. 26-​28. (​See Eurofinance.​co.​uk for more info.) Unfortunately, we won'​t be able to make it, but we hope the near-​negative yields on E105 billion Euro money market fund marketplace don'​t put too much of a damper on the festivities.

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The Investment Company Institute posted a brief entitled, "U.​S. Prime Money Market Funds Remain Cautious with Respect to Eurozone Holdings" Friday, which analyzes Crane Data'​s latest Money Fund Portfolio Holdings series and shows a chart of French and Eurozone holdings of Prime money market funds over the past 14 months. ICI'​s Emily Gallagher and Chris Plantier write, "Over the summer, prime money market funds marginally increased their holdings of eurozone issuers: from 12.​2 percent of assets in June (​chart) to 14.​0 percent of assets in August. This increase was driven primarily by a rise in holdings of French assets (​up to 5.​1 percent from 4.​3 percent in June) and in holdings of German assets (​up to 5.​1 percent from 4.​1 percent in June)."

ICI explains, "Since November 2011, this share of eurozone holdings has hovered in the 12 to 16 percent range -- roughly half of June 2011 levels -- and maturity of these holdings remains very short-​term. For example, 84 percent of prime money market funds' French holdings matured in thirty days or less at end August 2012, compared to 37 percent in June 2011."

In other news, Fitch Ratings released an update entitled, "MMFs Focus on Repo Counterparty Credit, Less on Haircuts." It says, "Money market funds' (​MMF) proportion of secured exposure in the form of repurchase agreements (​repos) has been on a secular rise for almost a decade. Fitch Ratings attributes this trend to a number of factors, including a shift in demand for secured assets, broadening collateral practices, and the general evolution of the credit markets. In addition, amended rule 2a-​7 has contributed to demand for repos by requiring taxable MMFs to hold at least 10% of their assets in daily liquid instruments (​such as overnight repos)."

Fitch'​s Viktoria Baklanova and Kellie Geressy-​Nilsen explain, "MMFs are focused on the counterparty credit quality first and foremost as the primary source of repayment. We believe regulatory requirements to maintain high quality short duration portfolios make it problematic for MMFs to take a possession of the long-​term collateral securities in the event of dealer insolvency.... Given this general limitation of the collateral acceptance, the levels of the collateral haircut have only secondary significance for MMFs and, therefore, historically these levels have not been dynamically adjusted to market conditions. With that said, we believe collateral could still serve as another source of repayment in the event of a counterparty default."

They add, "When rating MMFs, we assume funds will be able to liquidate available U.​S. government collateral without material loss of value. However, other types of collateral could become illiquid and cause funds to incur mark-​to-​market losses. Due to their greater volatility and lower liquidity especially at the times of market stress, nongovernment collateral securities are assigned greater haircuts, albeit not actively managed. In addition, our rating criteria limit rated MMF investments in repos backed by nongovernment securities to a maximum of 5% of the fund'​s assets, at par with other unsecured exposures. In essence, we attribute no value to such collateral."

Finally, Fitch writes, "Given the described limitations for MMFs in accepting repo collateral, in practice, MMFs are primarily focused on the quality of counterparty. We believe that transactions solely with counterparties rated at least '​A/​F1' are consistent with '​AAAmmf' ratings. Lastly, we explain the lack of active haircut management on the part of MMFs by the prevailing short duration of the repo transactions which are generally unwound on daily basis. Thus MMFs constantly re-​evaluate eligibility of the counterparty for the next-​day trade and may opt out of transacting with a counterparty whose credit quality deteriorates."

On another note, a press release entitled, "Federated Investors' Mutual Funds Acquire Approximately $​929 Million in Assets from Performance Funds Trust," says, "Federated Investors, Inc., one of the nation'​s largest investment managers, and Trustmark Corporation have reorganized approximately $​929 million in assets of funds of Performance Funds Trust into Federated funds with similar investment objectives. The reorganizations comprised assets of four equity, two fixed income and two money market Performance Funds."

The release adds, "​The reorganizations were approved by shareholders of the Performance Funds on Sept. 19, 2012. In connection with the reorganizations, Trustmark Investment Advisors, Inc., a wholly owned subsidiary of Trustmark National Bank, also sold certain assets relating to its management of the Performance Funds to Federated and certain Federated advisory subsidiaries. Following the consummation of these transactions, the Performance Funds will be terminated and, thereafter Trustmark Investment Advisors, Inc. will no longer serve as the sponsor and investment adviser to the Performance Funds."

It quotes Federated President & CEO J. Christopher Donahue, "Trustmark National Bank has been a valued client for many years, and we are pleased that they chose to work with us and transition these assets. Federated'​s wide range of investment options and our dedicated customer service can benefit Trustmark and its customers. Federated continues to seek alliance and acquisition opportunities in the United States and around the world."

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Today, we excerpt from our latest Money Fund Intelligence "​profile," "Interview w/​ICI'​s Karrie McMillan: In the Trenches." The article says: This month, we interview Karrie McMillan, General Counsel of the Investment Company Institute. The ICI, which is the trade association for the mutual fund industry, and McMillan have been in the forefront of the money market fund regulatory reform debate, both in the U.​S. and globally. Below, we discuss recent developments here and abroad, and we talk about what'​s next for money markets and mutual funds."

MFI: Could you briefly tell us a little about your history and about ICI'​s history? McMillan: I first really ran across mutual funds while I was at the SEC in the '​90s when I worked in the Division of Investment Management and the Chief Counsel'​s office. My goal was to avoid doing anything having to do with money market funds. I kept my head down and worked on everything else. We see where that has gotten me now! ICI has been working on money market fund issues since they first came into existence in the 1970s. Of course, there have been ebbs and flows, depending upon what is going on in the money market space. [​We sometimes went] through decades without really having much happening. But whenever there has been activity in the area, we'​ve been there ... with rulemaking, data, comments, etc. We'​ve been more active on money market funds of course since 2007 and 2008. But, in general, we'​ve been engaged on these issues here for quite a while.

MFI: On regulatory reform: is it over? McMillan: It is by no means over.... I think for right now it sounds like the SEC Chairman Mary Schapiro is not interested in pursuing further money market fund reform herself. The other Commissioners, Luis Aguilar, Troy Parades, and Dan Gallagher put out statements, as you know, that talked about areas where the Commission could provide value and learning. Then there is the handoff that the Chairman seems to have invited to the FSOC [​Financial Stability Oversight Council]. And then there is Europe. We were pleased that [​the SEC] pulled the proposals that were so troublesome.

MFI: What'​s next in the regulatory reform debate? McMillan: One thing that we'​ve all learned about money market funds is that you think the debate is headed one way and the next hour it has totally changed. At this moment, I feel like the next action is more likely to be in Europe. They are the ones now with the active ideas on the table or are in the development stage, whereas FSOC has been playing a more behind-​the-​scenes role in encouraging the SEC and Chairman Mary Schapiro. While I don'​t think this is going away, I do think that there may be, I hope, a little bit of time to stop and reflect.

In Europe, we are looking at IOSCO, which is meeting in early October to talk about the proposal that was put out in April. We, of course, commented on those. They are supposed to be turning over recommendations, I believe in November, to the FSB, so that is really coming up pretty quickly. ICI and several other fund associations are also having a summit in Brussels on October 4th where we will have a lot of thought leaders doing a one day seminar to try to engage in the money market fund debate over in Europe. [​Note: Crane Data is also involved in European Money Fund Summit, a conference in Frankfurt, Germany, Nov. 19-​20, 2012. See http://​www.​moneyfundsummit.​com.]

In some ways, I feel like Europe is where we were maybe two years ago in terms of understanding the importance of money market funds, the role they play in the economy, who the users are, their importance, etc. We are trying to provide the same education for policy makers over there that we did here in the United States. So this would be an important first start on that. On the top of that, there is the European Parliament and the work that they are doing on shadow banking that could also play into what happens with money market funds. So I think, for a while at least, our eyes will be looking over there.

MFI: What is your biggest challenge? McMillan: In terms of the policy challenge, there is this view of what happened during the crisis that seems unshakable. The rhetoric has ratcheted up and gone from, "​the money market funds were a contributing factor, an accelerant," to the latest FSOC report, which is we were "​the cause." It is very hard to get air space to confront this "​given" with facts, and have people understand what actually happened.

We will be publishing a paper in the near future that will walk through what we believe is a more accurate narrative that shows that the markets started moving, people were leaving the short-​term money markets, before Reserve announced its problems and before you saw outflows from money market funds. The hope is that this can provide more intellectual capital to the discussion. If you have a better sense of what actually occurred during the crisis, then you have a better sense of what should be done. [​Look for Part II of our MFI Interview in coming days.]

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Apparently, SEC Chairman Mary Schapiro is a very sore loser. She writes in today'​s Wall Street Journal an opinion piece entitled, "In the Money-​Market for More Oversight." Schapiro says, "Four years ago this week, amid the financial crisis, the U.​S. Treasury Department took the unprecedented step of putting taxpayer dollars on the line to stop a run on money-​market funds. That run exacerbated the crisis and helped spread its harmful effects from Wall Street to Main Street. It all occurred after the share price of a relatively unknown money-​market fund, the Reserve Primary Fund, fell below $​1, sunk by commercial paper from the bankrupt Lehman Brothers. This phenomenon, known as "​breaking the buck," meant that investors would get back less than they invested. Not wanting to take a loss, Reserve Primary Fund investors pulled their money out. It was a classic run."

Her editorial continues, "The experience was eye-​opening for policy makers, who saw firsthand the susceptibility of money-​market funds to destabilizing runs. While the Securities and Exchange Commission adopted rules in 2010 to make these funds more resilient, I said then and continue to believe that further meaningful reform is essential. There is a substantial consensus on the need for such reform—​proponents as diverse as The Wall Street Journal editorial board, columnists at the New York Times, and current and former regulators from both political parties have called for stronger rules."

Schapiro comments, "​The SEC'​s post-​crisis 2010 reforms were important but didn'​t address these structural flaws. The purpose of those reforms was to increase the resiliency of money-​market funds, primarily by instituting new liquidity requirements and mandating significant new disclosure of funds' holdings. But nothing in those reforms was intended to make money-​market funds better able to absorb losses. Nor were the reforms intended to reduce the likelihood of mass redemptions when investors fear losses. That is why, at the time, I called them a first step."

She adds, "While I respect the views of my fellow SEC commissioners, a majority of them recently chose not to publish the reform proposal for public comment. The decision at least provided some clarity: It gave others in government a green light to act where the SEC hasn'​t. At this point, the Financial Stability Oversight Council is the right organization to tackle this issue. Under the 2010 financial-​reform legislation, Congress created this council to serve as a cross-​regulatory body tasked with identifying risks to financial stability and promoting market discipline."

Schapiro writes, "The council already has signaled its support for action on money-​market funds. In each of its two annual reports, the council identified the susceptibility of these funds to runs as a risk to financial stability and encouraged the pursuit of reform. Now the council must consider what actions it can take to reduce this systemic risk. The options include, among others, the possibility of a formal recommendation to the SEC to apply new or heightened standards to money-​market funds. The SEC would then be required to apply those standards -- or within 90 days explain in writing the justification for not applying them. In addition, the council has the ability to designate certain entities as systemically significant and subject them to prudential regulation by the Federal Reserve Board. Individual regulators also can examine the sponsorship and reliance on money-​market funds by the entities overseen by the regulators, who would be able to consider whether additional limitations or controls are necessary."

Finally, she adds, "A run on money-​market funds hurt our financial system once and American taxpayers had to backstop them. The Financial Stability Oversight Council and all who care about financial stability must act to prevent it from happening again."

In other news, Bloomberg writes "​Return of FDIC Limits Seen Cutting Savers' Rates". The story says, "Money-​market funds may be swamped with a flood of cash that will drive interest rates even lower for savers, unless Congress acts by the year'​s end to continue unlimited federal insurance on certain bank deposits. The BGOV Barometer shows $​2.​3 trillion is sitting in non-​interest-​bearing bank accounts, a gain of 90 percent since the government in 2008 loosened limits on coverage by the Federal Deposit Insurance Corp. to help stabilize the banking system. Of that, about $​1.​4 trillion is in transaction accounts larger than $​250,​000, the previous ceiling for insured deposits, FDIC data show."

Bloomberg explains, "Restoring the limit might prompt holders of such accounts, including corporations and high-​net-​worth individuals, to withdraw the cash and turn to short-​term money markets. Such a flood of cash would potentially drive rates lower on a range of consumer-​investment products, such as money-​market mutual funds and certificates of deposit."

The piece quotes Morgan Stanley Strategist Subadra Rajappa, "People are not paying nearly as much attention as they should to this potential cash waterfall. If even 10 percent of the cash in these accounts is taken out because people were concerned about the safety of their money, there could be $​140 billion entering the Treasury and repo markets. This will have the effect of moving money-​market rates lower, which would definitely not be good for the money funds."

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Federated Investors refuses to rest in its battle against potentially threatening regulatory reforms. Earlier this week, the Pittsburgh-​based advisor posted a "Response to Securities and Exchange Commission Statement," which summarizes a number of rebuttals to SEC Chairman Mary Schapiro'​s crusade to dramatically alter money market funds. Federated writes, "During the past nearly two years, Federated has submitted public comments to the SEC, posted numerous materials on the Money Markets Matters website, conducted media interviews and discussed with investors the Company'​s strong opposition to SEC Chairman Schapiro'​s proposals to radically restructure money market funds. In the face of a well-​orchestrated drive by Chairman Schapiro, other regulators and their allies in the media, which sought to rewrite history and trafficked in storyline short on fact and long on fear, we have tried to set the record straight in a variety of ways, including regulatory filings, website postings, editorials, letters to the editor and media interviews."

They continue, "Chairman Schapiro abandoned her efforts in the face of opposition from a majority of her fellow SEC Commissioners but said she hopes other regulators take up the cause. The effort to eliminate money market funds as we know them may now be pursued in another regulatory venue such as FSOC and will likely be based on many of the same specious arguments. Therefore, we believe it is important to provide a point-​by-​point rebuttal to the formal statement that Chairman Schapiro released on Aug. 22. Where possible, we will also focus on the words of SEC Commissioners Gallagher, Paredes and Aguilar in their forceful and eloquent responses to their Chairman'​s statement."

Federated'​s response quotes from the "Statement of Chairman Schapiro," "The proposed structural reforms were intended to reduce their susceptibility to runs, protect retail investors and lessen the need for future taxpayer bailouts.... As we consider money market funds' susceptibility to runs, we must remember the lessons of the financial crisis and the history of money market funds. And, we must be cognizant that the tools that were used to stop the run on money market funds in 2008 no longer exist."

They then quote from the "Statement of Commissioners Gallagher and Paredes," "We were dismayed by the Chairman'​s Aug. 22, 2012, statement on the proposal she advanced to restructure money market funds. The current discourse about the Commission'​s regulation of money market funds is rife with misunderstandings and misconceptions.... The Chairman has recommended that the Commission approve a regulatory proposal that would have altered several fundamental features of money market funds. After careful consideration, we determined that the changes the Chairman advocated were not supported by the requisite data and analysis, were unlikely to be effective in achieving their primary purpose, and would impose significant costs on issuers and investors while potentially introducing new risks into the nation'​s financial system."

Federated'​s piece quotes from the "Statement of Commissioner Aguilar," "I remain concerned that the Chairman'​s proposal will be a catalyst for investors moving significant dollars from the regulated, transparent money market fund market into the dark, opaque, unregulated market.... I am also concerned that, given the current volatility of the capital markets and the fragile state of the economy, the timing of this proposal and its collateral consequences could be needlessly harmful."

On "MMF "​Restructuring" Alternatives," Federated again quotes Schapiro, "This inability to absorb a loss in value of a portfolio security and the incentive to run at the first sign of a problem are the two structural issues we were seeking to address with the proposals under consideration by the Commission. These are issues that are inherent in the structure of money market funds which came to the fore in the financial crisis, but undoubtedly are still present.... First, that money market funds float the NAV and use mark-​to-​market valuation like every other mutual fund. This would underscore for investors that money market funds are investment products and that any expectation of a guarantee is unwarranted.... Second, and alternatively, a tailored capital buffer of less that 1% of fund assets, adjusted to reflect the risk characteristics of the money market fund. This capital buffer would be used to absorb the day-​today variations in the value of a money market fund'​s holdings. To supplement that capital buffer in times of stress, it would be combined with a minimum balance at risk requirement."

They then excerpt from Commissioners Gallagher and Paredes, "Furthermore, we are concerned that the Chairman'​s proposal would, at a minimum, severely compromise the utility and functioning of money market funds, which would inflict harm on retail and institutional investors who have come to rely on money market funds for investing and as a means of cash management and on states, municipalities, and businesses that borrow from money market funds. Such adverse outcomes would undercut the SEC'​s mission.... The Chairman'​s approach would deprive investors of two fundamental benefits of money market funds: stability and liquidity.... [​T]​he capital buffer, even by itself, would seem to risk substantially crowding out the prime money market fund sector at the expense of both corporate borrowers and investors.... [​T]​he Chairman'​s proposal risks effectively ending prime money market funds as we know them.... We have consistently stressed that we should obtain the required data and undertake a rigorous analysis to determine whether any remaining risks associated with money market funds warrant fundamental structural changes like the ones the Chairman has urged. At present, we lack satisfactory answers to many crucial questions."

Federated comments, "Ms. Schapiro has recounted numerous times how either a floating NAV or a combo capital buffer/​holdback will cure the ills she sees in MMFs. What either would actually do is kill an incredibly popular (​even in a near-​zero interest rate environment) $​2.​5 trillion product that 56 million investors, businesses, state/​local government and non-​profit organizations depend on for cash management and funding purposes. And, while the SEC'​s public comment file contains numerous studies, surveys and analytics detailing the harm these proposals will do to business, government and the economy, backed up by letters with real life stories of the importance of MMFs from those who depend on the funds, the Commission has not done any research of its own to determine the potential impact of these draconian proposals."

They again quote Gallagher and Paredes, "Our view of the complex issues involved has been informed by the input of a range of market participants, including the many retail and institutional investors who have implored the Commission not to deprive them of the choice to invest in money market funds, as well as the interests of states, municipalities, and businesses that rely on money market funds as a key source of financing.... MMFs, currently with $​2.​5 trillion in assets, are the preferred cash management vehicle for businesses, government agencies, non-​profit organizations, colleges/​universities and financial institutions. For 56 million investors MMFs provide the only means to access a market rate, rather than a bank-​set rate. MMFs in turn provide short-​term financing for businesses, banks and state/​local government."

Finally, Federated concludes, "In the almost two years since the issuance of the President'​s Working Group report on money market funds, those who depend on money market funds have let their voices be heard. Over 2,​000 investors, businesses, state/​local governments, trade associations, non-​profits and financial professionals have written the SEC to support money market funds in their current form. Federated will continue to be very active in the battle to save money market funds and we are pleased that we are part of a broad and diverse group that believes money market funds are well regulated and the system, particularly in light of the 2010 amendments, is running smoothly."

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A statement entitled, "Fitch: Potentially Negative Euro Yields Won'​t Impact MMF Ratings," says, "Fitch Ratings says euro money market funds' (​MMFs) yields have stabilised at marginally positive levels two months after the ECB cut its deposit facility rate to zero. MMFs could nevertheless post negative yields if short-​term euro market rates move further into negative territory. This would not be a negative rating factor per se for Fitch-​rated MMFs. It would, however, lead fund managers to review their investment objectives and fund structural features."

The release continues, "Negative MMF yields stemming from the short-​term market rate environment would not be a negative rating factor per se for Fitch-​rated MMFs, including for those rated at '​AAAmmf'. Fitch recognises that MMFs yields are to be consistent with prevailing safety and liquidity costs, commensurate with alternative high-​quality short-​term instruments, such as '​AAA'-​rated euro treasury bills. The agency also highlights that Fitch MMF ratings must remain a ranking of funds on the basis of their liquidity, market and credit risk profile."

Fitch adds, "At end-​August 2012 constant net asset value (​CNAV) MMFs denominated in euro were generating net yields of 8bp on average, down by 11bp from their early July level, before the ECB rate cut. While fund managers are still able to find short-​dated euro assets delivering small positive yields, further potential actions by the ECB to reduce its reference rates would likely push market rates well into negative territory, and euro MMF yields ultimately as well.... So far, MMF managers have taken a series of measures to maintain their funds' yields above zero. These include partial fee waivers, which have already been implemented on about half of the euro CNAV funds, and/​or selective investment strategy adjustments, after an initial wave of closing funds to new investments."

Finally, they say, "Fund managers have now started to prepare for the possibility of negative yields on euro MMFs, reviewing fund structural features accordingly. This notably entails an adjustment of funds' investment objectives to introduce explicitly the notion of relativity to prevailing short-​term market rates. For CNAV funds, the stable NAV and related yield distribution mechanism is being reviewed with a view to limiting operational challenges as well as minimising accounting and fiscal implications for investors, without changing the investment pay-​off for investors. Euro CNAV MMF represented total assets of EUR106bn at end-​August 2012, of which EUR8bn were in government-​only MMFs. Overall, investors in euro CNAV funds have remained relatively stable throughout the summer, although government-​only MMFs experienced large investor asset outflows since early July (-​26%)."

In other news, Bloomberg wrote late yesterday a story entitled, "SEC Majority Said to Back Money-​Market Study Schapiro Opposed." It says, "A majority of U.​S. Securities and Exchange Commission members are seeking a study of money-​market regulations after Chairman Mary Schapiro'​s bid to advance new rules failed last month, a person familiar with the matter said. SEC Republican commissioners Daniel Gallagher and Troy Paredes, together with Democrat Luis Aguilar, sent a letter yesterday to Schapiro and SEC Chief Economist Craig Lewis reiterating a call for an analysis of whether certain rules could disrupt money-​market funds and short-​term credit markets, said the person, who asked not to be identified because the matter isn'​t public."

Bloomberg explains, "The request for the study comes about three weeks after Schapiro canceled a vote on staff proposals for new money-​market rules, saying that the SEC "​will not act" because three of the five commissioners did not support them. The statement, in which Schapiro dismissed the need for additional study, marked the start of an unusually public spat among the commissioners. Schapiro, backed by the Federal Reserve, has worked to make money funds more stable in the wake of the collapse of the $​62.​5 billion Reserve Primary Fund in September 2008. Its closing triggered a wider run on money funds, helping to freeze global credit markets."

The piece adds, "Schapiro'​s Aug. 22 announcement marked a victory for the mutual-​fund industry, which lobbied against new rules. The plan called for funds to abandon their traditional $​1 share price or adopt capital buffers and redemption restrictions, changes executives said would destroy products that manage $​2.​6 trillion for U.​S. companies and households.... In an Aug. 28 response to Schapiro'​s statement, Gallagher and Paredes said they supported an alternative proposal that would allow firms running money funds to prohibit withdrawals to stop investor flight in the event of a run. They also supported Aguilar'​s call for further study before proposing rules that could cause investors to move money from money-​market funds to other unregulated investment vehicles."

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Crane Data'​s latest Money Fund Portfolio Holdings, which were released to Money Fund Wisdom subscribers last Thursday, show that money market securities held by Taxable U.​S. money funds fell slightly by $​17.​3 billion in August to $​2.​266 trillion. A big increase ($​14.​5 billion) was again seen in `​Treasury Repo holdings and a jump ($​13.​5 billion) was also seen in CDs, while big declines were seen in Government Agency Debt (​down $​18.​3 billion) and Other Instruments (​Time Deposits) (​down $​8.​3 billion). European-​affiliated holdings declined slightly in August, falling from 29.​1% to 28.​9% of securities, after rebounding in July. (​Crane Data counts repo, ABCP and anything related to a European parent as "​Europe".) Eurozone-​affiliated holdings accounted for 12.​7% of overall taxable money fund holdings in August (​down from 12.​9% last month).

Repo continued to grow in August; it remains the largest segment of money fund holdings at 25.​7%, or $​583.​4 billion. This is comprised of 13.​4% Government Agency Repurchase Agreements ($​303.​6 billion), 9.​2% Treasury Repurchase Agreements ($​208.​3 billion), and 3.​2% of Other Repurchase Agreements ($​71.​5 billion). Treasury Debt stayed the second largest holding segment at 20.​1% ($​454.​5 billion), followed by Certificates of Deposit (​CDs) at 18.​4% of holdings ($​416.​9 billion) and CP at 15.​2% ($​343.​5 billion). Commercial Paper is the combined total of Financial Company Commercial Paper'​s 7.​9% ($​179.​7 billion), Asset Backed Commercial Paper'​s 4.​7% ($​106.​6 billion), and Other Commercial Paper'​s 2.​5% ($​57.​2 billion). Government Agency Debt continued to shrink to $​300.​0 billion in taxable MMF portfolios, or 13.​2%, Other securities (​Other Instruments, Other Time Deposits and Other Debt) dropped sharply to $​106.​4 billion, or 4.​7%, while VRDNs (​including Other Muni Debt) totalled $​61.​4 billion (​2.​7%) in August.

The 20 largest Issuers to taxable money market funds as of August 31, 2012, include US Treasury (​20.​1%, $​454.​5 billion), Federal Home Loan Bank (​6.​2%, $​140.​3 billion), Barclays Bank (​4.​1%, $​92.​7B), Deutsche Bank AG (​3.​6%, $​80.​8B), Federal National Mortgage Association (​2.​9%, $​66.​1B), Credit Suisse (​2.​9%, $​65.​3B), Bank of America (​2.​9%, $​64.​9B), Federal Home Loan Mortgage Co (​2.​8%, $​64.​2B), Bank of Tokyo-​Mitsubishi UFJ Ltd (​2.​6%, $​58.​4B), JP Morgan (​2.​4%, $​54.​6B), Sumitomo Mitsui Banking Co (​2.​3%, $​52.​7B), `​RBC (​2.​3%, $​52.​3B), Bank of Nova Scotia (​2.​3%, $​51.​0B), Citi (​1.​9%, $​43.​8B), Societe Generale (​1.​8%, $​41.​4B), BNP Paribas (​1.​8%, $​40.​4B), National Australia Bank Ltd (​1.​7%, $​38.​0B), Goldman Sachs (​1.​6%, $​35.​3B), Mizuho Corporate Bank Ltd (​1.​5%, $​34.​0B), and Credit Agricole (​1.​3%, $​29.​2B).

The United States remains the largest segment of country-​affiliations with 50.​3%, or $​1.​139 trillion, but Canada and Japan continue to grow. Canada (​8.​4%, $​190.​5B), the UK (​7.​4%, $​168.​4B), Japan (​7.​5%, $​169.​0B), and France (​5.​5%, $​124.​4B) rank second through fifth among the largest country affiliations. Germany (​5.​0%, $​112.​4B), Australia (​4.​4%, $​100.​5B), Switzerland (​4.​2%, $​94.​5B), Sweden (​2.​9%, $​65.​8B), and the Netherlands (​2.​9%, $​65.​6B) ranked sixth through 10th. Canada (​up $​15.​7B), Japan (​up $​11.​3B), and Germany (​up $​9.​0 billion) showed the largest gains in August, while Sweden and Switzerland both declined by over $​8.​0 billion. (​The U.​S. dropped by $​30.​3 billion, primarily due to the continued contraction in Government agencies and switch toward repo.)

Taxable money funds now hold 39.​0% of their assets in securities maturing in 1-​7 days. Another 17.​9% matures in 8-​30 days, while 26.​9% matures in the 31-​90 day period. The next bucket, 91-​180 days, holds 11.​4% of taxable securities, and 4.​8% matures beyond 180 days. Crane Data'​s Taxable MF Portfolio Holdings (​and Money Fund Portfolio Laboratory) were updated last week, while our MFI International "​offshore" Portfolio Holdings and our Tax Exempt MF Holdings were updated yesterday. Finally, note that we have begun "​beta" testing domestic and offshore Weekly Money Fund Portfolio Holdings; we (​along with some of our "​portal" clients) expect to announce their launch at next month'​s AFP Conference in Miami. (​Contact us for more details or to get on our trial list.)

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A statement entitled, "Corker Urges SEC to Continue Pursuit of Money Market Fund Reform to Protect Taxpayers from Potential Bailout," was released Friday by Senator Bob Corker'​s office. It says, "In a letter to the Securities and Exchange Commission today, U.​S. Senator Bob Corker, R-​Tenn., a member of the Senate Banking Committee, urged the commission to continue pursuit of money market fund reform to protect taxpayers from a potential bailout, building on the common ground established with an initial proposal from Chairman Mary Schapiro. Despite making progress, the SEC set aside further consideration of a proposed money market rule last month due to a lack of consensus among commissioners."

The Corker letter, addressed to all five SEC Commissioners (​Schapiro, Walters, Aguilar, Gallagher and Paredes), comments, "​I am writing to you today in regards to the SEC'​s recent efforts around money market fund reform. My concern is that a run on money market funds is still a real risk in the case of a financial system dislocation. As you know, about two thirds of assets in money market funds are institutional investor money, while one third of assets come from retail investors. In the event of a disruption in our financial system, Congress could be faced with a difficult choice: (​1) allow individual investors to bear significant personal losses while institutional investors (​who likely watch the commercial paper markets closely and would quickly recognize market distress) flee, or (​2) provide another bailout for a fund or the fund industry."

He continues, "Based on my read of Chairman Schapiro'​s initial draft proposal and the dissenting comments of some of the commissioners, I believe that the SEC may be honing in on a solution that might work. Both proposals point out the benefits of some form of a redemption restriction. Some observers in the industry have suggested a 3%-​5% withdrawal holdback for 30 days as a way to help prevent the collapse of a fund in case of a market panic. Generally, these observers also suggest a de minimis exception of some form for small retail investors. On the other hand, the dissenting view of some commissioners appears to advocate for a "​gating" approach that would allow some redemption restrictions managed by a fund'​s Board. It appears that there is common ground here around a set of rules that could stem a run and the potential need for government intervention. I am writing to encourage you to find an acceptable solution and move forward with a reform proposal along these lines for public comment."

Corker adds, "In the end, an optimal solution will be found if the SEC Commissioners and industry work together to find an appropriate structure that minimizes the risk of a wholesale run. Whatever that solution, reforms now are better than a taxpayer bailout down the road. Inaction is not an option."

In other news, former FDIC Chairman Sheila Bair, now at the Pew Charitable Trust'​s Systematic Risk Council, released a "Statement by the Systemic Risk Council (​SRC) on Money Market Fund Reform" late last week. It says, "We were deeply disappointed to learn that three SEC Commissioners have refused to publish for public comment a proposed rule to reduce the systemic risk posed by money market funds. Given the size and scope of this risk we believe the Financial Stability Oversight Council (​FSOC) -- and its members -- should use their individual and collective authorities to address this risk before another potentially destabilizing run."

The statement continues, "On July 19, 2012 the Systemic Risk Council called for prompt and decisive action to curb systemic risks posed by money market mutual funds. When the Reserve Primary Fund "​broke the buck" in 2008, extraordinary actions were required of governments worldwide to back-​stop and calm investors in the money market fund (​MMF) industry. The risk that emergency government support may again be needed to stem large outflows from money market funds remains a serious challenge for U.​S. and other markets. The Council believes such circumstances have been allowed to linger for too long and strongly supports proposals recommended by SEC Chairman Mary Schapiro."

It adds, "At that time, the Council also noted that "​In the event the SEC fails to act promptly on these measures, we believe that the FSOC should use its powers under the Dodd-​Frank law to move forward with reforms to protect taxpayers against the risk of a need for bailouts in the future." We applaud Chairman Schapiro for her leadership on this important issue, and we regret the unwillingness of a majority of the Commission to seek public comment on this vital reform. Given the current impasse at the SEC, we believe the FSOC should use the full range of authorities given it under Dodd-​Frank to effectuate needed reforms. These authorities include using Section 120 to formally recommend that the SEC move forward on Chairman Schapiro'​s recommendations, and using Title 8 to designate certain money market mutual fund "​activities" as "​systemically important" -- and requiring that the SEC impose heightened risk management standards as the FSOC determines necessary to address the risk. Clearly the SEC is best positioned to address this issue most efficiently, but, if the Commission continues to be unwilling to take the necessary action, FSOC must step in."

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The Federal Reserve announced more punishment for savers yesterday, launching another securities purchasing initiative while extending any rate relief for money market investors out to mid-​2015. The Fed'​s statement says, "​To support continued progress toward maximum employment and price stability, the Committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economic recovery strengthens. `​In particular, the Committee also decided today to keep the target range for the federal funds rate at 0 to 1/​4 percent and currently anticipates that exceptionally low levels for the federal funds rate are likely to be warranted at least through mid-​2015."

On the so-​called QE3 plan, the Federal Reserve Board of Governors' Open Market Committee comments, "To support a stronger economic recovery and to help ensure that inflation, over time, is at the rate most consistent with its dual mandate, the Committee agreed today to increase policy accommodation by purchasing additional agency mortgage-​backed securities at a pace of $​40 billion per month. The Committee also will continue through the end of the year its program to extend the average maturity of its holdings of securities as announced in June, and it is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-​backed securities in agency mortgage-​backed securities. These actions, which together will increase the Committee'​s holdings of longer-​term securities by about $​85 billion each month through the end of the year, should put downward pressure on longer-​term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative."

In other news, the Investment Company Institute announced plans for an "International Money Market Funds Summit" with a press release entitled, "International Fund Leaders Convene Money Market Funds Summit in Brussels." ICI says, "​Worldwide, money market funds are drawing increased attention from legislators, securities regulators, and central bankers. To address the issue on a global scale, five major fund organisations are joining forces to host the 2012 International Money Market Funds Summit on Thursday, October 4, in Brussels, Belgium."

It explains, "​The Investment Company Institute, ICI Global, European Fund and Asset Management Association, The Investment Funds Institute of Canada, and Institutional Money Market Fund Association are convening industry analysts and leaders, market participants, policymakers, and investors to address key money market fund topics, including: Value of money market funds to investors, issuers and the economy; The experience of money market funds in various jurisdictions in the 2008 financial crisis; Changes in money market fund regulations and practices since 2008; and, Assessing national and international regulatory recommendations."

The release reviews Global regulatory developments, saying, "In response to the 2007-​2008 financial crisis, regulators and policymakers around the world have considered changes to money market fund regulations. For example: The Financial Stability Board asked IOSCO to conduct a consultation into money market funds globally. It released a money market fund consultation report in April 2012. IOSCO recently announced that its Board will determine IOSCO'​s next steps on this topic at its meeting in Madrid on 3/​4 October, and will report to the G20 Finance Ministers meeting in November 2012. In Europe, in May 2010, CESR (​now ESMA) published guidelines on a common definition of European money market funds to improve investor protection. The new guidelines address the challenges faced by money market funds during the financial crisis, including standards relating to portfolio quality and maturity. More recently, the European Parliament'​s Committee on Economic and Monetary Affairs issued a draft report on shadow banking that includes a set of somewhat controversial proposals for money market funds. Furthermore, the European Commission has issued a UCITS consultation that includes as a topic the need to strengthen money market funds. The EC is considering a more harmonized and detailed European regulatory framework for money market funds and is seeking information to better understand possible reforms. For example the EC is seeking input on capital buffers, valuation methodologies, redemption restrictions, liquidity fees, and liquidity requirements."

Note that ICI'​s MMF Summit features many of the same speakers and topics as the European Money Fund Summit, which Crane Data is assisting with (​and which will be held Nov. 19-​20 in Frankfurt, Germany), but the two events are not affiliated.

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J.​P. Morgan Securities released its latest monthly "Update on prime money fund holdings for August 2012" yesterday, which showed increases in money fund assets, increases in European-​affiliated holdings, and increases in average maturities. The latest "U.​S. Fixed Income Strategy" research from Alex Roever, Teresa Ho and Chong Sin says, "Prime MMF assets under management rose by $​16bn (​1.​1%) in August, a month that was mostly uneventful for the money markets except for the anticipation leading up to the eventually cancelled SEC vote to release money fund reform proposals. ECB president Mario Draghi'​s "​whatever it takes to preserve the euro" speech at the end of July removed a significant amount of risk from the Eurozone peripheral sovereign markets and in turn, helped credit conditions improve for Eurozone banks. Uneventful is good for the money markets and some funds took advantage of the summer lull to add to their Eurozone bank positions and extend maturities."

The update continues, "Total net bank exposures in prime MMFs increased by $​17bn according to our estimates, driven by increases in unsecured CP/​CDs and repo and offset by decreases in time deposits. Overall ABCP exposures sponsored by banks remained flat month-​over-​month. In general, funds favored switching out of overnight time deposits (​unsecured) to overnight repo (​secured) for liquidity, which continued to trade at elevated levels in August with overnight GC repo averaging 20bp in the month. Also, some funds extended maturities slightly, primarily via unsecured CP/​CDs."

J.​P. Morgan explains, "Eurozone bank exposures increased by $​16bn with German bank exposures increasing by $​12bn. French bank exposures also increased marginally by $​3bn. As mentioned above, funds favored secured liquidity via overnight repo and some extension in maturities via unsecured CP/​CDs. Funds added exposures to Deutsche Bank ($​12bn), Credit Agricole ($​2bn) and BNP Paribas ($​2bn) among others. Year-​to-​date, Eurozone bank exposures are up by $​29bn, mostly through repo but are down by $​132bn on a year-​over-​year basis."

They tell us, "Non-​European bank exposures increased by $​10bn with increases to Japanese and Canadian banks offset by reductions to US banks. Funds continued to add to their Japanese bank exposures, increasing holdings by $​11bn in August, primarily via unsecured CP/​CDs. Year-​to-​date, Japanese bank exposures saw the largest increase at $​38bn compared to bank exposures from other regions. On a year-​over-​year basis, Japanese bank exposures increased by $​76bn. Prime MMFs currently hold the largest amount of unsecured exposures with Japanese banks followed by Canadian banks and Australian banks."

Roever, et. al., also write, "Prime MMF allocations to overnight repo increased to about $​200bn in August, up about $​25bn month over-​month and now represents over 70% of total repo holdings in prime MMF portfolios. Overnight repo holdings remain elevated even as regulatory pressures are forcing broker/​dealers to term out their funding liabilities. Basel III'​s Liquidity Coverage Ratio (​LCR) in particular would force broker/​dealers to hold government securities or cash for expected cash outflows over a 30-​day horizon. The bulk of repo funding which is overnight to inside a week would fall under LCR, making it costly for broker/​dealers to fund shorter than 30 days. We expect such supply pressures on repo over the next several months to lead funds to enter into more term repo trades and seek other sources of overnight liquidity. With repo being the staple overnight liquidity product for MMFs, supply pressures will pose a challenge for fund managers to maintain their daily and weekly liquidity requirements under Rule 2a-​7 (​10% and 30% of AUM, respectively). As government securities count towards MMF liquidity buckets, it'​s likely that prime MMF allocations to Treasuries and agencies will see gradual increases over the next several months."

They add, "​Global bank exposures in prime MMFs have been fairly stable over the past year ranging from $​970bn to $​1,​060bn and averaging about $​1,​030bn during that time period. In spite of the stability, not only has the mix of bank holdings have changed but the type of holdings have shifted as well as prime MMFs have increasingly favored secured forms of debt versus unsecured. If we look closer at the regional breakdowns, we see this shift has been significant for European banks, especially those in the Eurozone. The increase in secured holdings has been driven by repo and particularly those collateralized by Treasuries and agency MBS. Backed by high quality collateral and executed via triparty, repo provides additional layers of safety for MMFs over unsecured forms of debt, which given the macro risk uncertainty makes repo especially attractive. Combined with elevated repo rates since the start of Operation Twist, it'​s no wonder funds have favored repo. ABCP holdings, on the other hand, have been decreasing along with supply and we expect this trend to continue."

Finally, the update says, "Prime MMFs extended maturities for their unsecured bank CP/​CD holdings slightly in August but average final maturities still remain under 3 months. Average maturities of European bank unsecured CP/​CD holdings are at about 2 months and those of non-​European unsecured CP/​CD holdings are just below 3 months.... The month of August, for the most part, provided a nice respite for the money markets. With the SEC'​s money fund reform proposals off the table for now and the euro breakup risk significantly reduced, two of the largest issues in many fund managers' minds over the past year loom less large. That does not mean challenges do not remain for MMFs. In our view, further money fund reforms are not completely off the table and could find their way back on under the direction of the Financial Stability Oversight Committee (​FSOC), perhaps sometime after the Presidential elections. Also, as we'​ve written here and in prior publications, the shrinking universe of investible money market supply for many investors including MMFs remain a challenge."

Subscriber Note: Crane Data'​s Money Fund Portfolio Holdings with information as of August 31, 2012, will be sent to Money Fund Wisdom clients on Thursday morning, and our new Money Fund Portfolio Laboratory transparency and analytics module will also be updated then. Contact Pete (​508-​439-​4419) to request a copy of our latest holdings dataset. Our MFI International "​offshore" portfolio holdings will be released Friday.

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Investment Company Institute President Paul Schott Stevens penned yet another "Viewpoint" in response to an article on money market funds. Entitled, "Clearing Away the Misconceptions About Money Market Funds," it is in response to the New York Times' piece by James Stewart "​Influence of Money Market Funds Ended Overhaul". (​See our Sept. 10 "​Link of the Day".) Stevens writes, "A recent New York Times column contains a slew of mischaracterizations regarding recent developments around money market funds. Let'​s start with the negative, misleading headline: "​Influence of Money Market Funds Ended Overhaul." The fact is that the structural changes to money market funds recently under consideration by regulators inspired deep and varied opposition from across the country. True reform for money market funds would recognize the vital role that these funds play for investors and the economy and would make them stronger. That'​s exactly what the Securities and Exchange Commission achieved with its sweeping 2010 money market fund reforms, with full industry support."

He continues, "The 2012 proposed changes, however, threatened to destroy the value of money market funds for investors and disrupt a crucial source of financing for businesses, states, counties, and cities. Recognizing these risks, voices throughout the economy -- mayors of major cities, members of Congress from both parties, and scores of business and municipal organizations -- spoke out against the SEC staff'​s harmful plans. As a majority of SEC commissioners have stated, this broad-​based outcry was a key factor in stopping the proposed changes."

Stevens tells us, "​Stewart also mischaracterizes actions taken around money market funds in the financial crisis. Take his comments about the Treasury'​s Temporary Guarantee Program for Money Market Funds (​TGP), which expired in September 2009. He writes: "​Though largely unsung at the time, [​the TGP] was an important step that staved off a global financial collapse. It also made American taxpayers liable for over $​3 trillion, the total assets held by money market funds at the time.""

He counters, "As for making "​American taxpayers liable for over $​3 trillion," we'​re sorry to see this fiction persist. As we discussed in a previous ICI Viewpoints post, the structure of the program ensured that far less was at risk. How? The program only covered losses, which in turn were limited by the terms of the program: to file a claim, a fund was required to liquidate as soon as its value dropped by 0.​5 percent. And the government'​s exposure was capped at $​50 billion -- less than 2 percent of the $​3 trillion figure that Stewart and others bandy about."

Stevens adds, "As it happened, the TGP expired without receiving a single claim. Instead, Treasury and taxpayers received an estimated $​1.​2 billion in fees paid by participating money market funds. Other than that one-​year program, money market funds have never been insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency -- as these funds' investor disclosures and advertisements clearly state."

He concludes, "Finally, Stewart -- like many other commentators -- ignores the likely outcome of the SEC'​s proposed changes: they would increase, rather than reduce, systemic risk. Either forcing money market funds to "​float" their value or imposing capital requirements would drive away investors. Many of those assets could end up in less-​regulated cash pools that lack the requirements for credit quality, liquidity, maturity, and transparency applied to money market funds, and that may be beyond the reach of U.​S. financial authorities."

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Yesterday, speaking at Barclays Financial Services Conference in New York, BlackRock CEO Larry Fink blasted the "prolonged low rate environment," saying, "​This low rate environment is destroying the valuations of pension funds. I believe low rates [​are] creating greater fear with our savers and with our pensioners. I'​m not going to say low rates [​are] additive to the economy, but low rates [​are] an aggravator to the economy as we witnessed in Japan. I believe this low rate [​environment] is reflective of the lackluster investor confidence.... All this is causing is greater pension fund and retirement gaps, which I believe will become the largest problem in our country in the next 10 years."

In other news, a press release entitled, "Federated Investors, Inc. Acquires Approximately $​4.​4 Billion in Assets from Fifth Third Asset Management, Inc.," explains, "Federated Investors, Inc., one of the nation'​s largest investment managers, and Fifth Third Asset Management, Inc., an indirect wholly-​owned subsidiary of Fifth Third Bancorp, have reorganized approximately $​4.​4 billion in assets from four Fifth Third money market funds into four existing Federated money market funds with similar investment objectives. The transaction is not expected to have a material impact on Fifth Third Bancorp'​s results." (​See our April 6, 2012, Crane Data News piece "​Federated To Acquire (​The Rest of) Fifth Third Money Market Funds".)

Federated President & CEO J. Christopher Donahue comments, "Federated is a leading provider of liquidity management services, and we regularly work with organizations of many types and sizes as they evaluate their cash management needs. This transaction builds on Federated'​s long-​term relationship with Fifth Third by providing their clients with access to Federated'​s diverse range of products, experienced money managers, proven credit processes and extensive customer-​service capabilities. We will continue to consider and evaluate future opportunities for similar agreements with banks, insurers and broker dealers."

Finally, Moody'​s Investors Service issued a statement entitled, "London - Moody'​s says consolidation of MMFs is credit positive overall, though not without risks." It says, "The consequences of the 2008 global financial crisis and the regulatory changes that have followed have increased the pace of money market fund (​MMF) consolidation particularly in Europe over recent years, says Moody'​s Investors Service in a new Special Comment published today. Overall, the rating agency believes that the consolidation trend is credit positive for MMF investors and fund or asset managers, although there are some credit negatives associated with MMF consolidation."

Moody'​s release continues, "The challenges that have boosted the pace of MMF consolidation in Europe (​and more generally in the US over the last 10 years) include portfolio credit deterioration of sovereign, corporate, public finance and structured finance issuers, increased fund redemptions, liquidity challenges, low yields, and contracting supply of eligible securities. The credit-​positive effects of consolidation stem from the fact that MMF acquisitions or mergers typically result in (​i) the newly merged fund'​s lower expense ratio (​costs are spread over a larger asset base); (​ii) expansion of distribution channels and client relationships; (​iii) increased assets under management (​AUM) and improved economies of scale; and (​iv) potentially more resources in terms of credit research."

Finally, they add, "Moody'​s believes that the pace of MMF consolidation will continue, due to ongoing mergers and acquisitions of asset managers, economies of scale considerations, historically low interest rates pressuring fees, tightening regulatory regimes, product line rationalisation and resulting business exits for some managers."

​

The September issue of Crane Data'​s Money Fund Intelligence will be sent to subscribers later this morning, along with our August 31, 2012 monthly performance data and rankings. Our Money Fund Wisdom database query website has already been updated, and our Money Fund Intelligence XLS monthly spreadsheet, and Crane Index money fund averages will be released shortly. (​Our next monthly Money Fund Portfolio Holdings with 8/​31/​12 data are scheduled to be released on the 7th business day, Wednesday, Sept. 12.) The latest edition of MFI features the articles: "Money Fund Reform Dies: FSOC Unlikely to Revive," which discusses the recent withdrawal of the SEC'​s proposal; "Interview w/​ICI'​s Karrie McMillan: In the Trenches," which interviews the Investment Company Institute'​s General Counsel; and, "Shadow NAVs Show Very Little Floating," which reviews the mark-​to-​market prices of funds since November 2010.

The Death of Reform piece comments, "It'​s hard to believe, but it may actually be over. Money market mutual funds managers, who have lived with two virtual death sentences over their heads the last 3 1/​2 years -- zero interest rates and radical regulatory change -- had one of them removed in August as the SEC announced that it would not issue a proposal on money fund reforms. Though it'​s possible that reform will be taken up by the Financial Stability Oversight Council (​FSOC) or the Federal Reserve, it is unlikely that either will be able to usurp the SEC'​s authority over money funds."

Our monthly "​profile" on McMillan says, "This month, we interview Karrie McMillan, General Counsel of the Investment Company Institute. The ICI, which is the trade association for the mutual fund industry, and McMillan have been in the forefront of the money market fund regulatory reform debate, both in the U.​S. and globally. Below, we discuss recent developments here and abroad, and we talk about what'​s next for money markets and mutual funds."

McMillan says of the regulatory reform debate, "It is by no means over. I think for right now it sounds like the SEC Chairman Mary Schapiro is not interested in pursuing further money market fund reform herself. The other Commissioners, Luis Aguilar, Troy Parades, and Dan Gallagher put out statements, as you know, that talked about areas where the Commission could provide value and learning. Then there is the handoff that the Chairman seems to have invited to the FSOC [​Financial Stability Oversight Council]. And then there is Europe. We were pleased that [​the SEC] pulled the proposals that were so troublesome."

Our Shadow NAV says, "Below, we briefly take a look at taxable money market funds' "​shadow" NAV information since November 2010, when the SEC first began mandating the disclosure of this data via Form N-​MFP." We include a table with shadow NAV averages for the past 20 months, along with averages for the 90th and 10th percentiles.

The September MFI also contains monthly News, Indexes, top rankings and extensive performance tables. E-​mail info@​cranedata.​com 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).

​

Earlier this week, USA Today attempted to analyze the reasons behind the mountains of cash and reluctance to take risks in recent years. The article, "Financial crisis ushers in '​The Age of Safety' for investors," says, "Americans' risk-​taking DNA code has been short-​circuited. Investing used to be about taking risk to make money. Then came the financial crisis four years ago and the Great Recession. Now it'​s more about playing it safe -- and not losing the money you already have. The "​risk-​off" trade, or dialing down risk in a major way, is the new "​in thing.""

USA Today explains, "Risk aversion is at unprecedented levels. Cash, which guarantees a return of 0%, is one of the new must-​have investments. In contrast, investing in stocks -- despite the fact that the market has doubled in value since March 2009, is trading at four-​year highs and is up 11.​7% this year -- has fallen out of favor. Welcome to The Age of Safety. A psychological shift has taken place in the minds of investors. Fear has replaced greed as the overriding emotion driving investment decisions."

The paper quotes Peter Crane, president of Crane Data, "​a firm that tracks money market cash flows," "​You can go all the way back to the early 2000s, when the Nasdaq technology stock bubble burst. Then came 9/​11. Since then, you have had the creeping realization that it is a more dangerous world. Then the 2008 financial crisis drove home the point that it is a much more dangerous financial world. Both businesses and individuals realize they need larger cash war chests."

The piece adds, "As a result, he says, cash is viewed as the only true safe harbor. There'​s no shortage of statistics that scream "​safety": Cash hoarding. A record $​9.​43 trillion -- enough cash to buy 120 of the biggest companies in the Standard & Poor'​s 500-​stock index -- is now sitting in money market mutual funds, bank savings accounts and CDs, according to Crane Data. But all that cash isn'​t making anyone rich."

It quotes Crane on the money fund and bank money market deposit account total, "The rate of return is effectively zero. How much of the $​9 trillion is scared money is arguable. But the overall numbers are gigantic."

Finally, the paper comments, "​Main Street investors have been lightening up on stocks since the financial crisis. In the four years ending 2011, individual investors yanked more than $​395 billion out of stock mutual funds, according to the Investment Company Institute. In contrast, more than $​775 billion has been funneled into the perceived safety of mutual funds that invest in bonds. (​Mutual funds that invest solely in U.​S. stocks have seen outflows six straight years.) That trend of selling stock funds and buying bond funds has continued in 2012. Cautious companies in the S&​P 500 reluctant to hire or invest are also sitting on a near record $​1 trillion in cash."

In other news, ICI released its weekly "Money Market Mutual Fund Assets." It says, "Total money market mutual fund assets decreased by $​870 million to $​2.​570 trillion for the week ended Wednesday, September 5, the Investment Company Institute reported today. Taxable government funds decreased by $​3.​01 billion, taxable non-​government funds increased by $​340 million, and tax-​exempt funds increased by $​1.​80 billion." Year-​to-​date in 2012, money fund assets have declined by $​124 billion, or 4.​6%, but they have risen by $​32.​5 billion, or 1.​3%, since mid-​year (​June 27).

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Below, we excerpt from a couple recent discussion on the role of the Financial Stability Oversight Council, or FSOC, in possible future money fund regulations, and we also quote from a commentary saying Fed action involving IOER, or interest on excess reserves, is now very unlikely. Investors' Business Daily last week featured the article, "Dodd-​Frank Panel Could Rekindle Money Fund Fight" It said, "Hold the applause. Although Securities and Exchange Commission Chairwoman Mary Schapiro last week dropped her effort to tighten money fund controls, the fight might not be over. The next SEC chair could resurrect the issue. That could happen after Schapiro'​s term expires June 5, 2014. Or it could happen earlier if Schapiro resigns as a result of, say, the November elections."

IBD wrote, "​And industry observers see a real threat that the fight could shift to a potentially deadlier battleground. The Financial Stability Oversight Council (​FSOC) could try to impose the rules favored by Schapiro, or something even more draconian, says Mercer Bullard, a former SEC assistant chief counsel and founder of fund shareholder advocacy group Fund Democracy."

The piece quotes Peter Crane, president of Crane Data, "A floating NAV was kryptonite to funds. They hate it." IBD adds, "The FSOC, authorized by the 2010 Dodd-​Frank law, could ask the SEC to readdress money fund reforms. Or the FSOC could designate certain fund firms, such as the biggest ones with money market funds, systemically important. That would make them subject to rules such as Schapiro -- a member of the FSOC -- favored, or tougher."

On Tuesday, a Wall Street Journal blog wrote "​Money Funds Test Effectiveness of Dodd-​Frank". It said, "​To some observers, the whole value of the Dodd-​Frank financial law will be measured by how regulators resolve the mess over money-​market funds. To recap: A slew of top regulators including Federal Reserve Chairman Ben Bernanke and Treasury Secretary Timothy Geithner have said money-​market funds, which weren'​t addressed in Dodd-​Frank, are a threat to financial stability. Securities and Exchange Commission Chairman Mary Schapiro, who also supported new rules for money funds, called off a vote on a proposal because she didn'​t have enough support among her fellow commissioners."

The blog adds, "SEC action was seen as the best solution to fixing vulnerabilities the money-​fund industry, but Dodd-​Frank gives a super-​council of regulators, known as the Financial Stability Oversight Council, tools to jump in and the Fed could act in a limited capacity as well. If they don'​t use those tools, and quickly, investors shouldn'​t believe claims that Dodd-​Frank is making the financial system safer from systemic threats, argues Jaret Seiberg, a Washington analyst with Guggenheim Partners."

In other news, Federated Investors' Debbie Cunningham writes in her latest "​Month in Cash", "Treasury and repo rates have held fairly firm throughout the month, as we'​ve had good supply in both markets. We'​ve seen the overnight repo market holding in the mid-​to-​high teens, and Treasuries have been providing relatively decent returns in the three- to six-​month area of the cash-​yield curve. Commercial paper has remained steady as well."

On "Easing pressure for easing?," she comments, "Despite all the talk in the markets, we don'​t see it likely, without some sort of major market movement, that the Federal Reserve will announce any sort of new easing measures this month. We never thought another round of easing was as imminent as the headlines might have suggested during the dicey summer months, and now that economic data is starting to show some strength again (​thank you!), it seems there'​s even less justification out there."

Cunningham adds, "Should the Fed decide to go down that path, we continue to see the limited measure of an extension and/​or modification of Operation Twist, by either broadening the collateral types or widening maturities, as the likely choice. While there'​s always a chance of a full-​scale Quantitative Easing III, that'​s looking more and more like a distant runner-​up as conditions improve. The third option, lowering or eliminating the Interest Rate on Excess Reserves, or IOER, has fallen so far back that it'​s not really in the race any more. That'​s a good thing, though."

She says, "The ECB lowered its deposit rate in mid-​July from 25 basis points to zero and reduced its lending rate from 1.​0% to 0.​75%, and things did not go well. The ECB had hoped European banks would have pulled their deposits and moved them over to more productive and lucrative lending, to actual businesses, and spur some growth. The banks didn'​t cooperate, though, and now Europe is facing negative rates, zero loan growth, and, to top it off, less profitable banks. The move even had the perverse effect of causing European government money market funds to close to new investments so as to avoid further injury to their existing investors. Bottom line: Don'​t look for that kind of action here."

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A recent "Market Strategy" research piece from Barclays comments on the "Dealer repo activity." Strategist Joseph Abate writes, "​Overall, dealer activity in the repo market has held fairly steady in the past year. But dealer activity in the bilateral market is declining. Outside financing trades, dealers appear to be reversing in about the same amount of collateral. Dealers are active participants in the tri-​party and bilateral repo markets. They use the tri-​party market mainly to finance themselves and the bilateral repo market for trading specific collateral. Cash borrowings in the bilateral repo market have been falling since last summer. Bilateral repo now accounts for less than 35% of all dealer repo outstanding. Meanwhile, dealer tri-​party repo volumes are increasing. We estimate that money funds provide about 40% of the $​1.​5trn in tri-​party repo. Dealers are reversing in roughly the same volume of collateral in the bilateral market -- very little collateral is reversed in via the tri-​party market (​that is, outside of GCF)."

He continues, "We believe that pending regulatory changes will likely shrink the size of the tri-​party repo market. However, while some of these financing trades might migrate to the bilateral market, we suspect that dealers are more likely to shrink as their ability to maintain a $​600bn repo market funding gap declines."

Abate writes, "​Overall, dealer repo and reverses outstanding, as measured by weekly reports submitted to the Federal Reserve Bank of New York, has been fairly steady in the past year. In July, dealers had an average $​2.​7trn in outstanding repo and $​2.​0trn in reverses. However, these figures measure all dealer activity in the repo market -- they do not parse out what portion of the amount outstanding comes from the tri-​party or bilateral repo markets. Such a distinction might only be of interest to the handful of purists interested enough in the settlement mechanics of collateral trades to bother looking. However, dealer activity in each of these markets is driven by very different purposes and involves different counterparties. Moreover, as we noted several weeks ago ... the Fed is particularly concerned by the existence of intra-​day credit provided by the two clearing banks in the tri-​party market."

He explains, "In a tri-​party repo trade, the cash and collateral are exchanged between the borrower (​of cash) and the lender on the balance sheet of the clearing bank. Because the tri-​party bank takes care of settlement, collateral pricing, and facilitates collateral substitution, tri-​party trades are operationally more efficient than bilateral transactions. In bilateral transaction, the borrower and lender exchange cash and collateral simultaneously -- without the assistance of a third-​party. Because the bilateral transaction is less efficient, it typically trades at a less competitive rate than tri-​party repo transactions. Bilateral trades tend to involve specific collateral, like specials in the Treasury repo market."

Abate adds, "The lack of direct data on the size and activity in the bilateral market means that we have to estimate its size by netting out from the total dealer volumes outstanding all GCF and triparty transactions. Our figures only include Treasury, agency, MBS, and corporate collateral -- although we suspect that, like the tri-​party market, this collateral accounts for the bulk of bilateral repo trades. These data suggest that dealers borrow roughly $​1trn in bilateral repo trades -- an amount that has declined since last summer. Moreover, as a proportion of the overall amount of dealer repo, bilateral trades have shrunk from 44% to 34.​5%."

He says, "By contrast, activity in the tri-​party market has increased -– with dealer volumes rising from $​1.​3trn in May 2010 to $​1.​5trn in July 2012. Tri-​party financing trades now account for almost 70% of dealer repo (​cash) borrowings. In the past 12 months, tri-​party repo volumes have climbed 17%, driven by very sharp gains in dealer financing against Treasury and MBS collateral (​up 28% and 26%, respectively). A lack of new agency supply has reduced dealer pledging of this collateral by 7% in the past year, while at the same time corporate collateral (​investment and non-​investment grade) is being termed out and financed outside the repo market. Indeed, since last July, the Federal Reserve reports that the total volume of pledged corporate collateral has fallen by nearly 50%. Outside of this collateral, the volume of structured finance paper (​ABS, CMOs, for instance) has held steady as a share of overall triparty repo volumes. However, a recent Fitch report noted that the proportion of this paper funded by money market funds has increased sharply since 2009."

Abate adds, "Money funds traditionally do repo with dealers in the tri-​party repo market. And, over the past year, their demand for repo has increased. The $​100bn gain in the last 12 months has been driven by a number of factors, including a lack of government-​guaranteed supply (​as the agency debt market contracts), and Operation Twist sales that have caused a disproportionate back-​up in repo rates (​of more than 10bp since January). As a share of taxable money fund balances, repo has risen from 20% to 25%. At the same time, the volume of taxable money repo financing as a proportion of the total amount of dealer triparty repo outstanding has held steady around 40% in the past year. In effect, not only are money funds a significant source of dealer financing, but their importance has risen (​albeit mildly in percentage terms) in the past year."

Finally, he says, "As we recently wrote, we are not sure what the "​reformed" tri-​party repo market will look like, although we suspect that the market will be smaller and less non-​traditional repo will be funded in the market. A smaller tri-​party market -- particularly given the increase in its participation in the past year -- may create some congestion for money funds looking for safe investments among sparse government supply. But, there could be some relief if bilateral repo (​currently at $​1trn in outstandings) picks up the slack. However, this requires that some traditional tri-​party lenders such as money funds sacrifice some of the efficiency from the tri-​party market for access to more collateral in the bilateral market."

​

A recent study by University of Mary Hardin-​Baylor Assistant Professor Larry Locke and published in The Clute Institute'​s "​Journal Of Business & Economics Research" is entitled, "The SEC'​s Attempted Use Of Money Market Mutual Fund Shadow Prices To Control Risk Taking By Money Market Mutual Funds." The work'​s Abstract says, "One of the major advantages of money market mutual funds as a short term cash investment vehicle is that they are always purchased and sold for $​1 per share. That constant $​1 share price is maintained, despite the obvious fact that the funds' holdings are frequently changing value, through a permissive SEC regulation that entitles money funds to value their portfolio securities at amortized cost rather than market value. At the same time, funds have always monitored their true market value in what is referred to as the funds' "​shadow price", disclosed on a semi-​annual basis. Starting in December, 2010, the SEC ordered money funds to publish their shadow prices monthly in hopes that investors would take notice and provide market discipline to money funds that failed to keep the funds' market value sufficiently close to $​1 per share. The expressed intention of the SEC was that investors would restrain money market fund managers from taking undue risks. This study analyzes whether the SEC'​s strategy is working. By assessing the relationship between money market funds' shadow prices and subsequent changes in net assets, the authors can look for evidence of whether the market is performing the function the SEC intends. The authors have examined monthly disclosures of shadow prices and asset changes for over 100 money market funds since the funds commenced reporting. Through a series of linear regression analyses, the authors have found no relevant correlation between money funds' shadow prices and investor activity."

The Abstract adds, "The ramifications of this lack of correlation are potentially significant, particularly now as financial regulators are concerned that money fund holdings of European banks might transmit the current credit deterioration in Greece to U.​S. markets. The SEC and other financial regulators are counting on disclosure of shadow prices as a tool to avoid the kind of risk taking that ultimately contributed to the credit market freeze experienced in 2008. If that tool is, in fact, not working, the SEC may be obliged to attempt alternative strategies. The authors discuss the policy implications of their findings."

The full study says in its "History of Money Market Mutual Funds," "​What made the product possible, however, was a permissive rule under the Investment Company Act of 1940, Rule 2a-​7 (​17 CFR S 270.​2a–​7, n.​d.). Rule 2a-​7 allowed money funds to price their shares consistently at $​1 even though the true value of the shares fluctuated fractions of a cent up and down as the value of the funds' investment portfolios changed due to interest rate changes and credit events. Rule 2a-​7, however, had an important limitation. It made the fixed $​1 pricing only available to money market funds whose true share price (​or shadow price) remained within 1/​2 of one cent of $​1 per share, or between $​0.​995 and $​1.​005. (​Rule 2a-​7(​c)). Any deviation between the shadow price and $​1 per share greater than 1/​2 of one cent would require the Board of Trustees of the fund to take immediate corrective action, such as floating the fund’​s share price, suspending redemptions or liquidating the fund. (​Rule 2a-​7(​c)(​8)(​ii)(​B))."

It explains, "The implications of the lack of correlation found between shadow price disclosures and investor activity are potentially significant from a regulatory policy point of view. Financial regulators have a philosophical preference for allowing markets to discipline financial institutions. Financial regulation in the U.​S. relies heavily on market forces to reward firms that perform well and punish firms that do not. One of the major criticisms of the banking deposit insurance regime is that it creates a moral hazard by encouraging depositors to patronize the riskiest institutions (​who tend to pay the highest rates) (​McCoy, 2007). Because bank depositors enjoy the protection of federal deposit insurance, they need not fear losing their deposits and therefore fail to provide discipline to the banking industry. This study, however, indicates that money fund investors are not presently providing discipline to money fund advisors despite the absence of a government insurance program during the period of the study. It would instead provide evidence that investors have already succumbed to the moral hazard of believing that money market funds are not subject to risk of loss."

The paper continues, "It is possible that investors did not provide the hoped for discipline during the period of the study because it was not needed. The study captures only the first few months of the SEC'​s strategy being in operation and during that period there was not a Lehman Brothers-​type failure to motivate investors to discipline their fund managers. Nonetheless, the time frame of the study was a period in which money market funds were often in the news. The financial media published a number of stories about the financial crisis in Greece and its possible negative effect on money market funds through major French banks that are both lenders to Greece and borrowers from money market funds. (​Tudor, 2011), (​Farrell, 2011), (​Coy, 2011), (​Crane & Holding 2011). If there were a period in which headline risk would cause an investor to investigate the safety of their money market funds, the period of the study should qualify."

It adds, "It also is possible that as a particular fund'​s shadow price fell closer to $​0.​995 (​the point at which the fund would break the buck) the market would take notice and investors would begin to withdraw funds in substantial volumes. The lowest shadow price recorded in the data for the study was $​0.​9983. One could certainly imagine investors being more motivated to withdraw their money as a fund'​s shadow price reached $​0.​997 or $​0.​996. Even if a data point at that level had existed in the data analyzed by the study, the effect of investor activity in that one fund could have been severely muted by the size of the sample analyzed. The authors have presumed, however, that the SEC'​s goal is not to cause troubled funds to break the buck more quickly, but rather to provide a broad based market discipline favoring funds that tend to maintain higher shadow prices. It is that broad based discipline that the study indicates is currently absent."

Locke writes, "Without the assistance of the market to help discipline money market fund advisors, the SEC'​s obvious alternative might be to shoulder more of that burden through regulatory activity. Money market funds may need to be more frequently examined, more carefully monitored or more tightly constrained. The drawback of such an approach, of course, is that it sets the regulator and the industry in a state of perpetual conflict. The regulatory enterprise is also grossly understaffed and underfunded in terms of resources compared to the industry. In a speech given on January 27, 2010, Commissioner Aguilar made the point that the industry has grown from one fund in 1971 to over 750 funds and over $​3 trillion in assets with very little growth over that same period in SEC staff responsible for regulating money market funds (​Aguilar, 2010). The result can be one in which the SEC finds itself forever behind in a race to control the creativity of the industry seeking to take on a preferred level of risk without incurring the regulatory cost."

It says, "A possible alternative to applying more regulatory pressure might be to make a more clear call for investor discipline by making shadow prices more public, more quickly. Retail investors are unlikely to check the SEC'​s EDGAR database before purchasing a money market fund and even institutional investors might see this as an inefficient use of time and resources when the investment is likely to be very short term and the shadow price information available is already over 60 days out of date. If, instead, investors were able to access a fund'​s shadow price with less delay (​perhaps 30 days or even in real time) and if funds were required to publish the shadow price on their own web sites within that time period, it might conceivably result in a greater correlation between shadow prices and investor activity."

Finally, it concludes, "​This study is an example of how sometimes the absence of notable results is, itself, noteworthy. Notwithstanding the variety of regressions run by the authors, the results remain the same. The data provides no indication of a correlation between money fund shadow prices and changes in fund total assets. Interesting, because the entire reporting regime was instigated to create such a correlation. One could argue that the study is too longitudinally limited to detect the correlation but if that is true it cannot be helped. The study captured data for all months available. The study would have to be repeated at a future date to determine if more months of data would make a difference."

The study adds, "​The results of the study are potentially troubling from a regulatory policy perspective. If indicative of the investing public'​s fundamental attitude regarding money market mutual funds, the results suggest that market discipline is unavailable as a risk control device. If the SEC maintains its policy goal of further limiting risk taking by money fund managers it will either have to provide greater incentives to investors to supply that discipline or it will have to resort to means other than market forces. Either approach is available to the SEC. What may not be available is to do nothing. The potential systemic risk to the economy from money market funds has become too large to ignore."

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Below, we excerpt from Federal Reserve Chairman Ben Bernanke'​s speech Friday in Jackson Hole, Wyoming. His talk, entitled, "Monetary Policy since the Onset of the Crisis," says, "When we convened in Jackson Hole in August 2007, the Federal Open Market Committee'​s (​FOMC) target for the federal funds rate was 5-​1/​4 percent. Sixteen months later, with the financial crisis in full swing, the FOMC had lowered the target for the federal funds rate to nearly zero, thereby entering the unfamiliar territory of having to conduct monetary policy with the policy interest rate at its effective lower bound. The unusual severity of the recession and ongoing strains in financial markets made the challenges facing monetary policymakers all the greater."

He continues, "​Today I will review the evolution of U.​S. monetary policy since late 2007. My focus will be the Federal Reserve'​s experience with nontraditional policy tools, notably those based on the management of the Federal Reserve'​s balance sheet and on its public communications. I'​ll discuss what we have learned about the efficacy and drawbacks of these less familiar forms of monetary policy, and I'​ll talk about the implications for the Federal Reserve'​s ongoing efforts to promote a return to maximum employment in a context of price stability."

Bernanke comments, "When significant financial stresses first emerged, in August 2007, the FOMC responded quickly, first through liquidity actions--​cutting the discount rate and extending term loans to banks--​and then, in September, by lowering the target for the federal funds rate by 50 basis points. As further indications of economic weakness appeared over subsequent months, the Committee reduced its target for the federal funds rate by a cumulative 325 basis points, leaving the target at 2 percent by the spring of 2008."

He tells the Jackson Hole conference, "​The Committee held rates constant over the summer as it monitored economic and financial conditions. When the crisis intensified markedly in the fall, the Committee responded by cutting the target for the federal funds rate by 100 basis points in October, with half of this easing coming as part of an unprecedented coordinated interest rate cut by six major central banks. Then, in December 2008, as evidence of a dramatic slowdown mounted, the Committee reduced its target to a range of 0 to 25 basis points, effectively its lower bound. That target range remains in place today."

Bernanke adds, "Despite the easing of monetary policy, dysfunction in credit markets continued to worsen. As you know, in the latter part of 2008 and early 2009, the Federal Reserve took extraordinary steps to provide liquidity and support credit market functioning, including the establishment of a number of emergency lending facilities and the creation or extension of currency swap agreements with 14 central banks around the world. In its role as banking regulator, the Federal Reserve also led stress tests of the largest U.​S. bank holding companies, setting the stage for the companies to raise capital. These actions--​along with a host of interventions by other policymakers in the United States and throughout the world--​helped stabilize global financial markets, which in turn served to check the deterioration in the real economy and the emergence of deflationary pressures."

He says, "Early in my tenure as a member of the Board of Governors, I gave a speech that considered options for monetary policy when the short-​term policy interest rate is close to its effective lower bound. I was reacting to common assertions at the time that monetary policymakers would be "​out of ammunition" as the federal funds rate came closer to zero. I argued that, to the contrary, policy could still be effective near the lower bound. Now, with several years of experience with nontraditional policies both in the United States and in other advanced economies, we know more about how such policies work. It seems clear, based on this experience, that such policies can be effective, and that, in their absence, the 2007-​09 recession would have been deeper and the current recovery would have been slower than has actually occurred."

Bernanke explains, "As I have discussed today, it is also true that nontraditional policies are relatively more difficult to apply, at least given the present state of our knowledge. Estimates of the effects of nontraditional policies on economic activity and inflation are uncertain, and the use of nontraditional policies involves costs beyond those generally associated with more-​standard policies. Consequently, the bar for the use of nontraditional policies is higher than for traditional policies. In addition, in the present context, nontraditional policies share the limitations of monetary policy more generally: Monetary policy cannot achieve by itself what a broader and more balanced set of economic policies might achieve; in particular, it cannot neutralize the fiscal and financial risks that the country faces. It certainly cannot fine-​tune economic outcomes."

He tells us, "As we assess the benefits and costs of alternative policy approaches, though, we must not lose sight of the daunting economic challenges that confront our nation. The stagnation of the labor market in particular is a grave concern not only because of the enormous suffering and waste of human talent it entails, but also because persistently high levels of unemployment will wreak structural damage on our economy that could last for many years."

Finally, Bernanke says, "​Over the past five years, the Federal Reserve has acted to support economic growth and foster job creation, and it is important to achieve further progress, particularly in the labor market. Taking due account of the uncertainties and limits of its policy tools, the Federal Reserve will provide additional policy accommodation as needed to promote a stronger economic recovery and sustained improvement in labor market conditions in a context of price stability."

Money Market News Archive