Treasury’​s press release says, “Following the crisis, the Treasury Department directed the PWG to develop this report to assess options for mitigating the systemic risk associated with money market funds and reducing their susceptibility to runs. The PWG agrees that, while a number of positive reforms have been implemented, more should be done to address this susceptibility. The PWG now requests that the Financial Stability Oversight Council (​FSOC), established by the Dodd-​Frank Wall Street Reform and Consumer Protection Act, consider the options discussed in this report and pursue appropriate next steps. To assist the FSOC in any analysis, the Securities and Exchange Commission, as the regulator of money market funds, will solicit public comments, including the production of empirical data and other information in support of such comments. A notice and request for comment will be published in the near future. Today’​s release is one part in a series of steps that the regulatory community will be taking in the coming months to implement financial reform and to help ensure that the financial system continues to become more resilient.”

The report’​s Introduction explains, “Several key events during the financial crisis underscored the vulnerability of the financial system to systemic risk. One such event was the September 2008 run on money market funds (​MMFs), which began after the failure of Lehman Brothers Holdings, Inc., caused significant capital losses at a large MMF. Amid broad concerns about the safety of MMFs and other financial institutions, investors rapidly redeemed MMF shares, and the cash needs of MMFs exacerbated strains in short-​term funding markets. These strains, in turn, threatened the broader economy, as firms and institutions dependent upon those markets for short-​term financing found credit increasingly difficult to obtain. Forceful government action was taken to stop the run, restore investor confidence, and prevent the development of an even more severe recession. Even so, short-​term funding markets remained disrupted for some time.”

The PWG publication continues, “The Treasury Department proposed in its Financial Regulatory Reform: A New Foundation (​2009), that the President’​s Working Group on Financial Markets (​PWG) prepare a report on fundamental changes needed to address systemic risk and to reduce the susceptibility of MMFs to runs. Treasury stated that the Securities and Exchange Commission’​s (​SEC) rule amendments to strengthen the regulation of MMFs — which were in development at the time and which subsequently have been adopted — should enhance investor protection and mitigate the risk of runs. However, Treasury also noted that those rule changes could not, by themselves, be expected to prevent a run on MMFs of the scale experienced in September 2008. While suggesting a number of areas for review, Treasury added that the PWG should consider ways to mitigate possible adverse effects of further regulatory changes, such as the potential flight of assets from MMFs to less regulated or unregulated vehicles.”

It says, “This report by the PWG responds to Treasury’​s call. The PWG undertook a study of possible further reforms that, individually or in combination, might mitigate systemic risk by complementing the SEC’​s changes to MMF regulation. The PWG supports the SEC’​s recent actions and agrees with the SEC that more should be done to address MMFs’ susceptibility to runs. This report details a number of options for further reform that the PWG requests be examined by the newly established Financial Stability Oversight Council (​FSOC). These options range from measures that could be implemented by the SEC under current statutory authorities to broader changes that would require new legislation, coordination by multiple government agencies, and the creation of new private entities. For example, a new requirement that MMFs adopt floating net asset values (​NAVs) or that large funds meet redemption requests in kind could be accomplished by SEC rule amendments. In contrast, the introduction of a private emergency liquidity facility, insurance for MMFs, conversion of MMFs to special purpose banks, or a two-​tier system of MMFs that might combine some of the other measures likely would involve a coordinated effort by the SEC, bank regulators, and financial firms.”

The report explains, “Importantly, this report also emphasizes that the efficacy of the options presented herein would be enhanced considerably by the imposition of new constraints on less regulated or unregulated MMF substitutes, such as offshore MMFs, enhanced cash funds, and other stable value vehicles. Without new restrictions on such investment vehicles, which would require legislation, new rules that further constrain MMFs may motivate some investors to shift assets into MMF substitutes that may pose greater systemic risk than MMFs. The PWG requests that the FSOC consider the options discussed in this report to identify those most likely to materially reduce MMFs’ susceptibility to runs and to pursue their implementation. To assist the FSOC in any analysis, the SEC, as the regulator of MMFs, will solicit public comments, including the production of empirical data and other information in support of such comments.”

Finally, under “Policy Options,” the report discusses, Floating net asset values; Private emergency liquidity facilities for MMFs; Mandatory redemptions in kind; Insurance for MMFs; A two-​tier system of MMFs with enhanced protection for stable NAV funds; A two-​tier system of MMFs with stable NAV MMFs reserved for retail investors; Regulating stable NAV MMFs as special purpose banks; and Enhanced constraints on unregulated MMF substitutes.

You can see more on the Moody’s report from the Journal article, at http://www.moodys.com, or on my site (http://www.cranedata.com), but I wanted to add my comments from the WSJ website. I wrote:

Shilling and the Journal are incorrect in saying these 36 funds would have “broken the buck” without support from their advisors or distributors. In almost all cases of parental support, managers of money market funds take action to remove or protect a troubled security long before the $1.00 a share level is in serious danger. (Fund would act when the “shadow” price underneath was, say, $0.9975, half-way towards “breaking the buck.”) Of course, had the parent not removed a “Lehman Brothers” or a troubled SIV (structured investment vehicle), a series of events likely would have ensued leading to a “breaking of the buck.” But it’s pure speculation to say this would have occurred…. Note that even in the case of Reserve Primary Fund, the only major money fund to ever “break the buck,” the losses have amounted to less than a penny a share. Investors in this fund, the worst disaster in the history of the money fund business, still made more money than they would have in a bank checking account, after interest is taken into account. (They got back $0.99 and made 3-4% in interest in the 9 months leading up to Sept. ’08, so the returns for this fund were positive in 2008.) Finally, to respond to two comments above: No, Vanguard Prime was not one of the funds requiring support, and, GE did not have a money fund requiring support — they did have an “enhanced cash” fund that fell below $1.00, but these are not the same thing as a “money market fund”.

Yesterday, mutual fund newsletter ignites featured a Q&​A entitled, “​Are Funds Spending Less on Money Fund Biz?” A reader asked, “​Are mutual funds deemphasizing their money market fund businesses?” Crane Data’​s Peter Crane responded, “Most asset managers don’​t emphasize or spend a lot of money on sales and marketing for their money funds in the first place. But of course the zero-​yield environment has made marketing money funds an even tougher sell.”

He continues, “So marketing spending is likely down, though there are no good statistics on this. It’​s been almost 30 years since money funds were large and regular advertisers on TV and in national publications…. Overall, spending on money funds appears to be rising, though, driven primarily by costs related to the Securities and Exchange Commission’​s money market fund reforms.”

Crane adds, “​But the sector no doubt remains under pressure due to ultra-​low yields, asset outflows and regulatory uncertainty. While many have predicted a spate of exits and a rash of consolidation in the space, there still have been surprisingly few withdrawals from the money fund field.”

This weekend, the Associated Press wrote “​Don’​t count out money market mutual funds” (​here in the Boston Globe). The article says, “​It’​s hard to market any investment when its annual yield starts with a zero. Take money-​market mutual funds. Yields for the safest of safe-​harbor investments have been creeping close to zero for more than a year.

While we’​re still waiting for the final release of the full text of the SEC’​s recently passed Money Market Fund Reforms, we wanted to spend a little time dissecting the various SEC Commissioners’ speeches and comments from last week’​s Open Meeting. The reforms, which passed with a vote of 4-​1, were supported by Commissioners Elisse Walter, Luis Aguilar, Troy Paredes, and Chairman Mary Schapiro. Commissioner Kathleen Casey voted against the new money market fund rules.

Last week’s Wall Street Journal Fund Track column writes “​Money Funds Exhale After SEC Rules; Should They?. The article says, “​Some big players in the $​3.​3 trillion money-​market fund industry are breathing sighs of relief after regulators amended the rules governing the funds. There’​s a chance that relief may prove premature: The Securities and Exchange Commission, in making the changes last week, said it is still assessing the need for more fundamental reforms.”

The Wall Street Journal writes “​SEC: More Changes for Money-​Market Funds”. It says, “Money-​market funds could be forced to pay out less interest under new federal rules designed to make them sturdier. With memories still raw from the 2008 meltdown of Reserve Primary Fund, the Securities and Exchange Commission released rules on Wednesday that require funds to hold more liquid and higher-​quality assets and disclose the value of their assets per share more frequently. The trade-​off: These safeguards also will put pressure on yields that are already near zero. The changes likely will reduce yields by about 0.​10 percentage point, said Pete Crane, president of research firm Crane Data LLC.

I’d love to hear your thoughts!

While most market observers continue to believe that the Federal Reserve remains on hold as far as the eye can see, our admittedly rose-​colored outlook detects several baby steps towards a rate hike by mid-​2010. Yesterday’​s FOMC Statement says, “Information received since the Federal Open Market Committee met in November suggests that economic activity has continued to pick up and that the deterioration in the labor market is abating. The housing sector has shown some signs of improvement over recent months…. Financial market conditions have become more supportive of economic growth. Although economic activity is likely to remain weak for a time, the Committee anticipates that policy actions to stabilize financial markets and institutions, fiscal and monetary stimulus, and market forces will contribute to a strengthening of economic growth and a gradual return to higher levels of resource utilization in a context of price stability.”

The Fed continues, “​With substantial resource slack likely to continue to dampen cost pressures and with longer-​term inflation expectations stable, the Committee expects that inflation will remain subdued for some time. The Committee will maintain the target range for the federal funds rate at 0 to 1/​4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period.”

Finally, they say, “In light of ongoing improvements in the functioning of financial markets, the Committee and the Board of Governors anticipate that most of the Federal Reserve’​s special liquidity facilities will expire on February 1, 2010, consistent with the Federal Reserve’​s announcement of June 25, 2009. These facilities include the Asset-​Backed Commercial Paper Money Market Mutual Fund Liquidity Facility, the Commercial Paper Funding Facility, the Primary Dealer Credit Facility, and the Term Securities Lending Facility…. The Federal Reserve is prepared to modify these plans if necessary to support financial stability and economic growth.”

In other news, the Investment Company Institute recently issued the statement, “ICI Statement on House Passage of Regulatory Reform Bill,” which says, “​ICI President and CEO Paul Schott Stevens made the following comment on the House of Representatives’ approval of H.​R. 4173, a bill designed to reform the nation’​s financial regulatory system: ICI supports modernization of the U.​S. financial services regulatory framework…. However, a number of provisions included in the House-​passed bill must be addressed as the legislative process continues. Among other things, the bill, in its current form, could subject mutual funds to wholly inappropriate forms of bank-​like regulation were regulators, however improbably, to deem mutual funds to be a source of ‘​systemic risk.’ In addition, the bill could unfairly require mutual funds and their shareholders to contribute to a dissolution fund for failing financial institutions. Mutual funds do not and cannot ‘​fail’ in a manner that would require payments to funds or their shareholders out of any such dissolution fund. We look forward to continuing to work with Congress to resolve these issues.”

But The Wall Street Journal says in “​Fund Industry Bristles at Bill,” “​Not everyone is persuaded by ICI’​s arguments. The fund group’​s refusal to acknowledge that money-​market funds could fairly fall under the new rules undermines its broader arguments, said Mercer Bullard, associate professor at the University of Mississippi School of Law and president of Fund Democracy, an advocacy group for mutual-​fund shareholders.”

It continues, “​From the start, our goal was to return money to investors as quickly and fairly as possible and to avoid the extended quagmire of litigation that would have only served to deplete the finite pool of money used to pay investors. With this goal in mind, the SEC took the lead in proposing a just and equitable resolution and forging a consensus among the vast majority of investors who recognized the benefits of resolving this matter amicably…. The proposal by the SEC advocated a pro-​rata distribution plan that provides an equal payout to all shareholders who have not had their redemption requests fulfilled, regardless of when they submitted those redemption requests. It is estimated by the Reserve Fund that the amount to be returned would be 99 cents on the dollar, or more.”

Shapiro continues, “Without this distribution plan, shareholders would have been racing to obtain judgments against the finite pool of funds, possibly leading to conflicting judgments by different courts and tapping into a $​3.​5 billion pot that had been set aside by the Fund to cover litigation costs. In fact, approximately 30 lawsuits already had been filed across the country at the time we proposed our plan. The SEC plan approved by the court eliminates these claims on the remaining assets, freeing up money to be returned to investors. Today’​s ruling affirms our approach and should enable all investors to get back their money quickly.”

The SEC says on background, “​On September 15, 2008, the Reserve Primary Fund, which held $​785 million in Lehman-​issued securities, became illiquid when the fund was unable to meet investor requests for redemptions. The following day, the Reserve Fund declared it had ‘​broken the buck’ because its net asset value had fallen below $​1 per share. On May 5, 2009, the SEC filed fraud charges against several entities and individuals who operate the Reserve Fund for failing to provide key material facts to, and affirmatively misleading, investors and trustees about the fund’​s vulnerability as Lehman Brothers Holdings, Inc. sought bankruptcy protection. More significantly, in bringing the enforcement action, the SEC sought to expedite the distribution of the fund’​s remaining assets to investors by proposing a plan of liquidation.”

It adds, “In its complaint, the agency asked the court to enter an order compelling a pro rata distribution of remaining fund assets, which would release money that is currently being withheld from investors pending the outcome of approximately 30 lawsuits against the Reserve Fund, the trustees and other officers and directors of the Reserve entities.”

It continues, “The investors thought they were buying safe short-term securities — sort of like a money market fund but with an expectation of a slightly higher return. The securities were supposed to be easy to sell for face value. Now, Mr. Norris says, many of the investors are stuck with securities that pay ridiculously low yields. In some cases, the securities will never mature, so the investors will never get their money back unless they sell them for a fraction of what they paid. Those who thought they were being safe and cautious in fact were taking huge risks.”

As we wrote in a comment, calling the auction-rate securities market “forgotten” is a laugher. The New York Times has written about this tiny sector of the investment marketplace more times than I can count. Investors, all clearly qualified, sophisticated institutions, enjoyed outsized returns for years. Meanwhile, The Times never uttered a peep. Why didn’t they question why the sector was able to pay higher rates than money market mutual funds? Investors accpeted the returns, so were clearly were aware of the risks. Any additional attempts to extort more money from financial institutions only rewards a handful of lawyers and punishes the vast majority of investors who had enough sense to avoid higher-yielding “free lunches” like auction-rate securities in the first place.

Crane Data recently surveyed MFI subscribers and readers of our website at www.cranedata.com about the SEC’s recent Money Market Fund Reform Proposals and issues facing money funds. The responses indicate that ultra-low interest rates have surpassed regulatory changes as the most important issue facing money funds, and that the proposals overall are rated relatively favorably.

MFI e-mailed the brief survey questions to its 800+ readers and received 26 responses. Respondents included primarily money fund managers and sales professionals, but also a number of money fund investors and money market securities issuers. We first asked readers to rate the SEC’s proposals on a scale of 1 to 10, with 10 being the highest. The average score was 6.3. The SEC proposals overall got ‘8’ scores (the highest) from 7 respondents and ‘1’ scores from two. (See page 2 for a summary of the full survey results.)

 Like Liquidity Mandates, Hate 30%

 We then asked, “Which of the SEC’s proposed MMF Reform amendments do you think would do the most good?” The most popular option, “Adding liquidity mandates,” was chosen by 48.3% of respondents. This was followed by “Other” (20.7%), where the majority of write-in options cited the 120-day maximum “spread WAM” as likely the most effective mandate.

 The next question asked, “Which of the SEC’s Proposed MMF Reform Amendments do you think would do the most harm?” Responses were widely distributed with “Moving WAM from 90 to 60 days” garnering the most votes (27.6%), followed again by “Other.” This time the write-ins included: “introduction of Floating NAV,” “differentiating between retail/institutional funds, as it relates to liquidity requirements (30% 7 day punitive!),” and “showing the shadow price to investors.”

 MFI then asked, “What are the most important issues facing money market mutual funds in the coming months?” Respondents were asked to rank the choices (see below left) in order of importance.

 “Ultra-low interest rates” ranked the most important issue (1.7), followed by “Regulatory changes” (2.2), “Competition from banks or new products” (3.6), and “Rising rates” (3.8). “Consolida- tion” trailed in importance (3.9) followed by “Other” (4.3), where a couple of write-in responses included the,  “threat of floating NAV.”

We then asked readers to “Rate the attractiveness of a floating NAV.” Though the overall average of 3.5 indicates this concept’s unpopularity among the money fund community, there were some surprising pockets of support for the idea.

Ten of our 26 respondents rated the concept a ‘1’ (plus one who went off the scale with a zero), while 4 respondents gave the concept a ‘10’. One respondent commented, “potential changes to accounting treatment make it less desirable.”

We then asked, “If you could add or remove a change, what would it be?” Survey takers’ comments included: “Change liquidity mandates,” “I would nix removal of illiquid securities,” “Remove floating NAV from comment consideration,” “In addition to the punitive 30% 7 day liquidity bucket for institutional funds (should be lower) the ‘maturity limit for other portfolio security’ should not be reduced from 397 days,” “Removing second tier securities,” “2nd tier reinstated,” “Removing illiquid securities,” “Liquidity mandates,” “Limit FRNS longer then 12 months and limit the % of FRNs in the fund,” and “don’t change illiquid bucket.”

Finally, we asked, “Are there any other important issues you think Crane Data should address in a comment letter or in an article?” Readers said: “US government support in the form of liquidity backstop would help the industry. Not an FDIC insurance but a perpetual program to buy securities, or lend against them in the event of market  disruptions,” “The notion of having to distinguish between retail and institutional funds for determination of liquidity requirement,” “Definitely have concerns with publicly publishing actual security prices. Eliminating illiquid securities could potentially stifle innovation — why not have a low max of say 5%?”

Investors in particular responded unfavorably to a theoretical floating rate NAV. One wrote, “If the NAV were re-priced and allowed to float, [our bank] would likely be forced to remove 100% of the $50M we have invested in MMFs. We do not want to be forced out of the MMF market!”

MFI SUBSCRIBER SURVEY           

1. Overall, on a scale of 1 to 10 with 10 being the highest, how do you rate the SEC’s MMF Reform proposals?            Average           6.3

2. Which of the SEC’s Proposed MMF Reform Amendments do you think would do the most good?   

a. Moving WAM from 90 to 60 days.   10.3%

b. Removing Second Tier Securities      6.9%

c. Adding Liquidity Mandates   48.3%

d. Removing Illiquid Securities   6.9%

e. Disclosing monthly portfolio holdings 6.9%

f. Other ________       20.7%

3. Which of the SEC’s Proposed MMF Reform Amendments do you think would do the most harm?   

a. Moving WAM from 90 to 60 days.   27.6%

b. Removing Second Tier Securities      10.3%

c. Adding Liquidity Mandates   10.3%

d. Removing Illiquid Securities   20.7%

e. Disclosing monthly portfolio holdings 6.9%

f. Other            24.1%

4. What are the most important issues facing money market mutual funds in the coming months?            

 (rank highest to lowest with 1 being the highest, 2 being next, etc.)        

a. Regulatory Changes  2.2

b. Consolidation           3.9

c. Ultra-Low Interest Rates       1.7

d. Rising Rates  3.8

e. Competition from Banks or New Products    3.6

f. Other            4.3

5. On a scale of 1 to 10 with 10 being the highest, rate the attractiveness of a floating NAV.      

Average           3.5

Source: Crane Data.

The full report says, “​At the end of 2008, European money market funds had EUR 1,​350 billion under management, compared to EUR 1,​186 billion at end 2007…. The main domiciles of money market funds at end 2008 were France (​EUR 488 billion), Luxembourg (​EUR 335 billion) and Ireland (​EUR 319 billion). These three domiciles represented 85% of the European money market funds market.” See http://www.cranedata.com’s News for the full article and links.

The While we appreciate any effort by Europe and others to restrict the use of the term “​money market fund” to only those vehicles adhering to strict regulatory oversight and abiding by strict quality, maturity, diversity, and soon liquidity, standards like those in the U.​S., we believe the splitting of categories will continue to only confuse the marketplace. We would urge Europe to restrict the term “​money market” to only the “​short-​term,” highest quality, and most liquid securities. However, we look forward to the discussion and appreciate the efforts of IMMFA and EFAMA. (​Note that IMMFA Chairman Travis Barker is scheduled to speak at Crane’​s Money Fund Symposium in Providence August 25.)