An advisory committee organized under the Treasury Department on Tuesday voted unanimously to move forward with a set of proposed rules intended to stabilize money-market funds and prevent a run on assets similar to the jolt the market experienced during the financial collapse of 2008 and 2009.
The Financial Stability Oversight Council (FSOC) moved the set of three proposals to the next stage in its administrative process, asking for public comment on the proposed rules that the Securities and Exchange Commission would ultimately draft and enforce.
Treasury Secretary Timothy Geithner, who chairs the council, said that shoring up money-market funds is "essential to the financial stability of the United States," adding that lax oversight of the sector "helped accelerate and exacerbate the financial crisis of 08 and 09."
The options the council proposed include a requirement for funds to float their net asset value (NAV) by eliminating an accounting exemption. That measure would seek to stabilize funds by tracking share prices more closely to the underlying value of their portfolios. If the SEC implemented that recommendation, it would bring money-market funds into line with the pricing structures of other mutual funds.
Alternatively, the council proposed that money-market funds could be required to maintain a baseline level of capital as a buffer, suggesting a threshold of no more than 1% of their total assets. Another proposal would set the threshold at 3% of assets, but under that framework funds could lower the buffer by adopting other steps to demonstrate stability.
Of the various options for stabilizing money-market funds and insulating investors from the harm brought on by a run, SEC Chairman Mary Schapiro firmly signaled her support for the floating NAV proposal to price shares in accordance with their mark-to-market values.
"I personally believe that floating NAV is the pure option, the simplest option, and the option that is most consistent with the SEC's regulatory approach to investment products," Schapiro said. "It provides clarity of value, and enables investors to enjoy gains and share in losses as is appropriate in a pooled investment."
Federal officials highlight the importance of stability in the sector of money-market funds, which comprise an important supply of short-term funding for businesses, financial firms and governments, and figure prominently as a cash-management tool for both individual and institutional investors.
Following the collapse of Lehman Brothers in 2008 and the drop of shares of the $62 billion Reserve Primary Fund below $1 -- a circumstance known as breaking the buck -- investors scrambled to cash out of money-market funds, seeking to redeem some $300 billion in prime funds in a matter of days. At that time, the Treasury Department and Federal Reserve took emergency steps to staunch the run, including Treasury's guarantee of more than $3 trillion in prime money-market funds and liquidity programs overseen by the Fed.
"The runs in 2008 were stopped only by extraordinary interventions by the government -- the Treasury and the Federal Reserve using powers which, incidentally, are no longer available," said Fed Chairman Ben Bernanke. "The runs showed the structural vulnerabilities in money-market funds, specifically that they promise a fixed, stable share price of one dollar, even though they have credit risk and incomplete or limited portfolio liquidity."
Bernanke and others praised the SEC for undertaking a series of reforms in 2010 that added new requirements for money-market funds concerning liquidity, credit quality, maturity and disclosure. That same year, however, concerns about the European debt crisis prompted another run on U.S. money-market funds, albeit of a far smaller scale than two years earlier.
Officials heading the FSOC were in uniform agreement that the SEC needs to take adopt new rules to shore up money-market funds by creating a climate that disincentivizes investor runs.
"The run on prime money-market funds undoubtedly was a core part of that financial crisis, yet the run abated only after unprecedented federal government intervention in the form of the taxpayer-funded Treasury guarantee program, as well as the liquidity facilities established by the Federal Reserve Board," Schapiro said. "As regulators focused on financial stability, we owe it to all Americans to take appropriate steps to prevent our financial system and the nation's taxpayers from again finding themselves in the same precarious position."
The FSOC's recommendations are meant to inform a rulemaking process that the SEC would undertake under its own authority, and Geithner indicated that the council will not proceed with final recommendations unless the SEC fails to take action.
"Our hope of course is that a public debate on a series of concrete options will help provide a basis for the SEC to move forward," Geithner said. "Our preferred course, and I think ultimately this is what's essential, is for the SEC to take this back and propose a set of options on its own."
