September 27, 2013 6:28 pm

Boston Fed president criticises proposed money market reforms

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The president of the Federal Reserve Bank of Boston launched a broadside against proposed changes to the $2.6tn money market mutual fund industry, saying they risk making the financial system less safe.

Eric Rosengren’s comments underscore deep divisions between regulators over one of the unfinished post-crisis reforms, designed to prevent runs of the kind that occurred after Lehman Brothers collapsed in 2008.

Proposals by the Securities and Exchange Commission “might be worse than the status quo”, Mr Rosengren said.

“We haven’t in any way resolved the kind of problems that occurred in the crisis. The credit risk is still there for the prime money market funds . . . I really don’t view this as a reform at all.”

Investors treat money market funds as akin to bank accounts, since they maintain a fixed value of $1 per share even while the value of their underlying assets fluctuates around that.

Losses on Lehman Brothers debt caused the oldest fund, the Reserve Primary, to “break the buck”, meaning it could not return all its investors’ money. The result was a panic by institutional investors and a run that was only halted when the federal government guaranteed all money market funds.

The SEC put forward compromise proposals in June that would introduce sweeping changes to some money market funds, but exempt those that cater to retail investors or which invest mainly in super-safe government debt.

The proposal has two options, either a floating net asset value (NAV) or a system to limit investor withdrawals in times of market stress. The regulator is considering giving individual funds a choice of which measure to introduce.

Mr Rosengren and the other 11 regional governors of the Fed wrote a letter to the SEC this month criticising the proposed rules and arguing that the agency should focus on imposing a floating NAV on the widest possible range of funds.

Mr Rosengren’s criticisms focused on the SEC’s proposed “liquidity fee”, which would require a money market mutual fund to impose a fee of not more than 2 per cent on redemptions if the fund’s weekly liquid assets fall below a certain level, and a new ability to impose “temporary gates” against redemptions.

The measures are meant to discourage investors from yanking their money away from a fund in times of stress, but the Boston Fed president said the two reforms “fundamentally change the money market mutual fund product during a crisis” in a way that is likely to encourage investors to head for the exits.

“Now the investor must consider how other co-investors in the same fund will behave: if other investors run, the investor could be faced with gates and fees even though the underlying assets have experienced no change in value.”

Money market funds are central to the supply of short-term credit to the economy. The fund management industry has pushed back strongly against any reforms, while the Fed has pushed for more radical changes than those contemplated by the SEC.

Mr Rosengren was speaking at a conference held by the Federal Reserve Bank of New York on “stable funding” in the financial system.

During the conference, which was held under Chatham House rules with the exception of Mr Rosengren’s remarks, speakers acknowledged that some critical weaknesses in the financial system remain unresolved more than five years since the start of the crisis.

In his speech, Mr Rosengren noted that “many of the structural weaknesses that lie beneath these ‘run’ episodes have yet to be fully addressed by market participants and policy makers”.

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