Money market funds may suffer when federal backstops expire, J. P. Morgan exec fears

Stringent liquidity rules proposed by SEC could also hurt industry

Aug 25, 2009 @ 11:16 am

By Sue Asci

Money market mutual funds would benefit from a federal program to guard against the risk of illiquidity in the markets, analysts yesterday at the first Money Fund Symposium in Providence, R.I.

Liquidity in money market funds drew regulatory attention after the industry experienced a run on the market in September 2008 when The Reserve Primary Fund, offered by the Reserve Management Co. Inc. of New York, fell below its net asset value of $1.

As a result, money fund assets dropped to $3.4 trillion as of Sept. 24, 2008, from a peak of $3.6 trillion on Sept. 3, 2008, according to the Investment Company Institute of Washington.

“It shut down the ability to borrow for those who needed funding, like broker-dealers, U.S. and foreign banks,” Alexander Roever, managing director at J.P. Morgan Securities Inc. of New York, said at the conference sponsored by Crane Data LLC of Westborough, Mass.

“That became systemic risk. That makes the argument for a backstop to be put in place.”

Several federal lending facilities put in place to help support liquidity in the commercial paper market are set to expire in February.

Paul Volcker, the former Federal Reserve chairman and an adviser to President Obama, said today in an interview with Bloomberg that money market funds threaten the banking system and should be regulated in a fashion similar to banks.

In addition, the Treasury Department's Temporary Guarantee Program for Money Market Funds, set up to offer insurance to guarantee money market mutual fund deposits as of Sept. 19, 2008, is scheduled to expire next month. It is widely believed the program will not be extended.

The Securities and Exchange Commission is also seeking comments on its proposed rules to reduce risk in money funds and ensure safety for shareholders.

“The question is does the set of [Securities and Exchange Commission] proposed rules do that, and it's not clear that they do,” Mr. Roever said.

The rules include tighter liquidity requirements and would lower the weighted average of maturity for a portfolio to 60 days, from 90 days.

But if new restrictions result in lower yields, investors may pull out.

“But the [rules] may chase the investors to other places,” Mr. Roever said.

“The investors will eventually go to higher-yielding places. It could be the second coming of the enhanced cash fund market.”

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