In a recent speech, Eric Rosengren, the President of the Federal Reserve Bank of Boston, outlined his concerns about the credit risk in prime money market funds as they are currently regulated as well as their potential to contribute to broader economic instability.
He discussed the holdings of prime money market funds, stating that Tier 1 securities represent a range of credit worthiness including securities that have significant credit risk. He emphasized the importance of reviewing credit risk on a fund by fund basis. He went on to say that the fact that money market fund did not experience runs or break the buck during the European debt crisis was not evidence that the 2010 amendments solved all problems in money market funds. "We should care not only about the realized losses, but also about the potential losses associated with risk exposures. From a policy perspective, we should in short care that significant risks were taken even though the potential bad outcome did not occur."
Mr. Rosengren went on to describe the difficulties that first emerged in 2008 that prompted many fund sponsors to provide financial support to their funds to avoid "breaking the buck." He advocated a system that did not rely on government or sponsor support even during difficult markets.
To mitigate the risks inherent in the structure of money market funds, Mr. Rosengren offered potential solutions, including a floating NAV, capital requirements, and a cost on redemptions - acknowledging weaknesses inherent in these proposals. He emphasized that the status quo was not adequate and commended the SEC's work on reform. "Everyone knows the SEC is working very hard on this and could have a proposal for reforms out in the coming months. I strongly commend their efforts to arrive at reforms that reduce the risks surrounding money market funds."
He encouraged the industry to embrace some reform that could both strengthen money market funds and improve financial stability. "But all in all I believe the risks to the stability of the financial system that underpins the economy are too great not to take the actions that will make the industry and our financial system more stable."
The full speech is available at http://www.bos.frb.org/news/speeches/rosengren/2012/041112/index.htm.