The need for further regulations governing money market funds was once again hotly debated at
Senate Banking Committee hearings last week. At the hearings, Treasury Secretary Timothy Geithner reiterated his concerns that the 2010 money market reforms enacted by the SEC just do not go far enough, and doubled down on his commitment to see the SEC enact further measures, saying: "My own judgment is that the SEC needs to go further. They can go further. And we should get on with the business of letting them expose to the world, to the markets, a set of options that the world can comment on." Senator Corker added that he believed that the Financial Stability Oversight Council (FSOC) could act if the SEC fails to move forward with further money market fund reforms.
At the same time, however, Senator Pat Toomey (R-PA) argued that the 2010 reforms may have been sufficient and questioned whether money market funds are truly susceptible to runs and pose systematic risks. Toomey worries, he says, that the reforms being considered by the SEC are unworkable and could put money market funds out of business.
Geithner responded that, while money market funds are less vulnerable than they would be absent the 2010 reforms, they are still susceptible to runs that could potentially hurt investors and damage the the financial system. Geithner's opinion is backed up by the heads of the New York and Boston Fed, SEC Chair, and two members of FSOC, who also have publicly stated that money market fund reforms must go further because of the concerns around systemic risk. In addition, in its annual report, the FSOC endorsed additional money market fund reform and urged the SEC to publish structural reform options for public comment and ultimately adopt reforms addressing money market funds susceptibility to runs. The FSOC cited two characteristics of money market funds that continue to contribute to their susceptibility to destabilizing runs: (1) the funds have no mechanism to absorb a sudden loss in the value of a portfolio security without threatening their stable $1.00 NAV and (2) there continues to be a "first mover advantage" in money funds which can lead investors to redeem at the first indication of any perceived threat to the value or liquidity of the money market fund.
Though many are urging further money fund reforms, there seems to be no consensus on what form those reforms should take. SEC Chair Mary Schapiro has stated that the SEC is considering options for further reform like a free floating NAV, rather than a firm $1 NAV, perhaps a capital buffer, and a redemption restrictions. A recent NY Federal Reserve Bank
staff report proposes another alternative introducing a minimum balance at risk for money market funds in order to make the financial system safer and reduce systemic risk. The minimum balance at risk proposal would theoretically would provide a disincentive to withdraw funds from a troubled money fund. While the balance at risk idea retains the stable $1 NAV, it is also a blend of the capital buffer and redemption restrictions.
Others, like Boston Fed chief Eric Rosengren see money market funds as even more fundamentally dangerous, particularly because they are undercapitalized.
Money market mutual funds provide investors with an investment vehicle with features like bank deposits – but the funds do not hold capital. The problem is that a financial intermediary – which has no capital, but takes credit risk, and provides under normal circumstances immediately available funds at a fixed net asset value – may be inviting trouble.
In addition to more structural reforms to money funds, Rosengren
proposes taking a further step by using stress tests to illuminate the impact of various scenarios on fund sponsors, many of which are banks or financial institutions.
In the absence of such reforms for all money market mutual funds, an alternative for funds with depository institution or depository institution affiliated sponsors would be to include likely money market mutual fund support in the sponsor’s stress tests. Based on the historical experience of their money market funds, the historical experience of similar funds, and their money market funds’ exposures, sponsors could calculate the likely capital support needed from the organization in a stress scenario.
While it is clear that momentum is building amongst powerful policy makers for some sort of additional regulation of money funds, the debate over how far these reforms should go and what form they should take is nowhere near settled.