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Money Funds Lift Government Debt in Liquidity Grab, Fitch Says

Money-market mutual funds, in an effort to increase liquidity while reducing market-volatility risk and meeting regulatory requirements, have focused since 2007 on boosting holdings of government debt, according to Fitch Ratings.

U.S. government securities, including Treasuries and agency debt, saw the largest increase among rises in liquid assets held by money funds, according to Fitch’s analysis of data from the 10 largest U.S. prime money-market mutual funds in a report published yesterday.

The percentage of fund assets invested in Treasuries and agencies rose to 22 percent as of the end of September, from 2 percent in August 2007. Liquid securities overall rose to 45 percent of funds’ assets at the end of September from about 20 percent at the end of 2006, the Fitch report showed.

The Securities and Exchange Commission enacted several rules changes for money funds in 2010 amid efforts by regulators to make the industry more stable after the Sept. 16, 2008, collapse of the $62.5 billion Reserve Primary Fund.

Investors withdrew about $310 billion from prime money funds that week, helping to freeze global credit markets. The Treasury and Federal Reserve stepped in with guarantees and other steps to stop the run. Rules created included minimum liquidity levels for the first time, reduced maximum allowed average maturity of holdings and new disclosure requirements.

SEC Changes

“A meaningful portion of this increase is attributable to SEC rule changes implemented in 2010, which among other restrictions place a 30 percent floor on the level of liquid assets available in one week or less” wrote authors of the report, led by Martin Hansen, New York-based senior credit director at Fitch.

Fitch broadly defines liquid assets as money funds’ direct holdings of U.S. Treasury and agency securities, irrespective of maturity, as well as other bank and corporate investments, including repurchase agreements, with a residual maturity of one week or less.

“The sizable liquidity buffer that funds are holding beyond these new regulatory minimums also reflects money-market funds risk aversion,” the authors wrote. “Once market volatility eases, Fitch expects funds will, in turn, seek to reduce these buffers and take advantage of higher-yielding, longer-duration investment opportunities.”

Geithner Effort

Treasury Secretary Timothy Geithner on Nov. 13 urged the SEC to pursue new rules for money-market mutual funds, triggering fresh opposition from industry leaders who had beaten back similar proposals and are pursuing a weaker overhaul.

Geithner, heading a Washington meeting of the Financial Stability Oversight Council, a group formed by the Dodd-Frank Act to address systemic financial risks, won unanimous approval for a draft recommendation to the SEC spelling out three ways to overhaul the $2.6 trillion industry.

The Fitch money-fund sample represents roughly $646 billion, or 45 percent, of the Investment Company Institute’s estimate of about $1.44 trillion in total U.S. prime money-market funds assets under management.

Prime money-market-fund investments include bank certificates of deposits, commercial paper, repurchase agreements and short-term notes and deposits.

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