William C. Dudley, president of the
Federal Reserve Bank of New York, said new rules are needed to protect the financial system from a run on money-market mutual funds, lending his support to a regulatory overhaul proposed by U.S. Securities and Exchange Commission Chairman Mary Schapiro.
“A glaring vulnerability exists with money-market mutual funds,” Dudley wrote today in a Bloomberg View column. “Money funds should have capital buffers and modest limits on investor withdrawals. Such reforms are necessary to protect the economy from financial instability in the future.”
Capital cushions and redemption restrictions are part of Schapiro's plan to bolster money-fund regulation. She has so far failed to win enough backing among her four fellow commissioners, who may vote as early as this month on whether to ask for public comment or kill the proposal.
Any of 105 U.S. money funds with combined assets of about $1 trillion could have been forced below its $1 share price by a single default among its 20 biggest borrowers, Dudley wrote in the column, citing Treasury data.
The number of vulnerable funds increased to 219 if a default occurred among any fund's top 10 borrowers, according to the annual report of the Treasury's Office of Financial Research published last month. The study assumed 40 percent recovery on all unsecured lending and full recovery on a fund's repurchase agreements.
Industry opposition
Federal Reserve Bank of Boston President Eric Rosengren has also publicly supported Schapiro's plan. Other prominent supporters include Treasury Secretary Timothy F. Geithner; his predecessor, Henry Paulson; and former Fed Chairman Paul Volcker.
They are opposed by the funds industry, which has lobbied against the proposal; the U.S. Chamber of Commerce; and lawmakers including Senator Patrick Toomey, a Pennsylvania Republican.
Regulators have worked to make money funds more stable since the September 2008 collapse of the $62.5 Reserve Primary Fund. Its closing after its share price “broke the buck” by falling below $1 triggered a wider run on funds that helped freeze global credit markets. The withdrawals abated after the Treasury Department guaranteed shareholders against losses for a year and the Federal Reserve began buying securities at face value to help funds meet redemptions.
Withdrawal limits
Schapiro's plan would force funds to abandon their fixed $1 share price or introduce withdrawal limits and capital buffers, a move industry executives say would destroy the $2.5 trillion product. Floating net-asset values would be a “significant improvement” over the stable $1 share price because “it would reduce the incentive for shareholders to get out early in times of stress,” Dudley said. “But it wouldn't eliminate the incentive to run altogether.”
The SEC passed rules in 2010 that introduced liquidity minimums, new disclosures and shorter maturity limits. Congress has since prohibited the Treasury from acting similarly again and restricted the Fed's ability provide emergency liquidity.
Regulators say they worry that money funds, the biggest source of short-term credit in the U.S., remain vulnerable to investor runs and could again further destabilize markets during a crisis.
“Contrary to what some in the industry suggest, run risk didn't end when the SEC sensibly tightened rules on money-fund holdings in 2010,” Dudley wrote.
Doubting 'Demise'
He also disputed the industry's contention that Schapiro's plan would destroy the appeal of money funds and deprive companies, cities and states of a valuable source of funding.
“I seriously doubt that the reforms I propose would lead to the demise or even the radical restructuring of the money- market-fund industry,” he wrote.
Moody's Investors Service said today that the credit profiles of money funds denominated in U.S. dollars, British pounds and euros deteriorated in the second quarter due to “credit pressures on financial institutions in both Europe and the U.S.”
About 8 percent of the underlying investments by U.S. dollar funds shifted to A2 from A1 or higher rated securities “mostly due to the credit deterioration of banks and securities firms with global capital markets operations,” the rating company said in a statement. Euro-denominated funds saw a similar shift in 20 percent of investments.
Aguilar's vote
Schapiro's plan is supported by commissioner Ellise B. Walter and opposed by Troy Paredes and Daniel M. Gallagher. Luis A. Aguilar has signaled his opposition without saying whether he would kill it before inviting public comment.
Money-market funds are regulated by the SEC. If the agency doesn't pass additional rules, the Financial Stability Oversight Council, a panel created by 2010's Dodd-Frank Act, could subject them to direct oversight by the Fed. Charged with identifying threats to the financial stability of the U.S., the FSOC is headed by the Secretary of the Treasury and its nine other voting members include the Fed chairman and heads of the SEC and Federal Deposit Insurance Corp.
