Money-market funds in the U.S. may be taking excessive risks that pose a threat to financial stability by holding European debt whose value could decline if the region’s crisis worsened, said Federal Reserve Bank of Boston President Eric Rosengren.
“A significant source of the credit risk in many prime money market funds over the past year has been the large exposure to European banks,” Rosengren said at Stone Mountain, Georgia, today. In evaluating “risk from unexpected problems in Europe, money-market funds remain an important potential transmission channel to the United States,” he said.
Rosengren presented the most detailed public argument yet by a Fed official on the need for new money fund rules. Regulators and executives of the $2.6 trillion industry have debated how to make the funds safer since Reserve Primary Fund’s collapse in 2008, which triggered industrywide investor withdrawals that contributed to a freeze in global credit markets.
Rosengren endorsed proposals by staff at the U.S. Securities and Exchange Commission to reduce risk by requiring firms to maintain capital buffers or to redeem shares at the market value of underlying assets rather than at a fixed price of $1.
“The status quo is not acceptable,” he said. “Funds need to be structured so that neither sponsor support nor government support is likely or necessary, even during times of stress.”
Lehman Brothers Collapse
Rosengren’s comments echoed Chairman Ben S. Bernanke, who called this week for additional steps to curb “shadow banking” operating beyond standard oversight.
“Additional steps to increase the resiliency of money market funds are important for the overall stability of our financial system and warrant serious consideration,” Bernanke said.
Following the bankruptcy of Lehman Brothers Holdings Inc. in 2008, Bernanke flooded the financial system with liquidity by opening facilities that provided credit to money market funds, primary dealers, commercial paper markets and banks.
The 2008 run on money funds abated only after the U.S. Treasury guaranteed their shareholders against losses for a year and the Fed began buying fund holdings at face value to help them make redemptions.
The Dodd-Frank financial overhaul prohibits the Treasury from repeating such a bailout, and government officials, including SEC Chairman Mary Schapiro, have vowed to avoid putting taxpayer money at risk again in defending the product.
Breaking the Buck
Money fund executives have argued that the industry’s woes were limited to the $62.5 billion Reserve Primary Fund, which fell below its $1 share price, or “broke the buck,” in September 2008 because it held about 3 percent of its assets in debt issued by Lehman Brothers.
In 2010 the SEC introduced liquidity minimums, average maturity limits and new disclosure requirements. Schapiro has since said additional steps are necessary to strengthen the product. Rosengren agreed with that assessment in today’s comments.
“The assumption of significant credit risk is not appropriate for intermediaries that have no capital and implicitly promise a fixed net asset value,” he said. “Without additional reforms, this structural problem could trigger or amplify future financial stability problems.”
Rosengren gave figures on the number of money funds that required bailouts from their parent companies during and since the financial crisis. At least 47 funds have received direct support via cash contributions or through an outright purchase of distressed securities at above-market prices, he said.
Rosengren also presented data on the risk level of money fund holdings, as measured by the price of credit-default swaps, which represent insurance for debt buyers against default.
Twenty-three percent of holdings in prime money funds as of Sept. 30 had an issuer, sponsor or liquidity provider with a CDS quote of between 200 basis points and 300 basis points, compared with 30 basis points for U.S. government securities, he said.
“This highlights that credit markets are assigning a significant chance that some money market fund investments that current regulation deem permissible could in fact default,” he said.
Rosengren’s speech comes after the fund industry has made increasingly public protests over the SEC’s plans, supported by the U.S. Chamber of Commerce and some members of Congress.
Federated Investors Inc., the third largest U.S. money-fund provider, has threatened to sue should the SEC proceed with either of its plans.
Rosengren, who was formerly a bank regulator at the Boston Fed, said some funds have taken on excessive credit risks that are not understood by investors and “absent some changes, still pose some risks to financial stability.”
The Boston Fed president didn’t comment on the U.S. economy or monetary policy in his prepared remarks.