In a speech today in lower Manhattan, Boston Fed president Eric Rosengren made the case for strong money market mutual fund reform, which he believes is overdue.
Money market mutual funds (MMMFs) grew rapidly during the period leading up to the financial crisis, but experienced a significant outflow when the failure of Lehman Brothers led the Reserve Primary Fund to “break the buck” (becoming unable to maintain a fixed $1 per share net asset value). Concerned that other funds with exposure to Lehman might not be able to maintain their NAVs, investors ran from prime MMMFs, causing significant disruption in short-term credit markets.
“Many of the structural weaknesses that lie beneath these run episodes have yet to be fully addressed by market participants and policymakers,” said Rosengren. “MMMF runs should not be allowed to once again impede the flow of stable funding within our financial system.”
“Promising a fixed NAV with no capital while taking credit risk is not sustainable,” said Rosengren, “especially in potential future crises where the response of the public sector will be substantially limited, compared to 2008.”
The SEC recently proposed two MMMF reforms, and Rosengren recommended some changes and enhancements to the two proposals.
The first SEC proposal would treat institutional prime MMMFs like other mutual funds and allow the value of a share of the fund to float with the value of its underlying assets. The second proposal would require the fund’s directors to impose a fee on all redemptions in the event that the fund’s liquid assets fell below a specified threshold. (The proposal gives the fund’s directors discretion to impose a lower fee or no fee if they determine that such action is not in the best interest of the fund.)
“The SEC proposal to allow funds to impose liquidity fees and redemption gates should be dropped,” said Rosengren. “This particular proposal is, in my view, worse than the status quo. Liquidity fees and gates fundamentally change the investor’s decision-making process during a financial crisis” in a way that “might actually increase run risk” and “only increase the risk of financial instability.”
But Rosengren strongly supports requiring a floating NAV for all prime funds, both institutional and retail, which would treat those funds like other mutual funds. “With a floating NAV, if the assets properly reflect market values, the incentive to run that stems from the possibility of ‘breaking the buck’ under the current rules should be significantly reduced.”
Rosengren noted that “MMMF reform is overdue. However, it is important that the reforms actually reduce the financial stability issues that remain.”