Chairman Johnson, Ranking Member Shelby, Members of the Committee.
I appreciate the opportunity to testify about money market mutual funds and the continuing
risks they pose to our financial system.
As we all know, during the financial crisis, a single money market fund – known as the
Reserve Primary Fund -- ‘broke the buck’ triggering a run not only on that fund, but
on funds across the market.
Within a matter of days, investors had withdrawn about $300 billion from prime money market
funds – or 14% of those funds’ assets.
It was one of several destabilizing events during the financial crisis.
To meet their customer’s redemption demands, money market funds began selling portfolio
securities into markets that were already under stress, further depressing the value
of those securities and creating a vicious cycle.
Soon, other funds holding those same securities were struggling to meet the demands of their
customers and found themselves at risk of “breaking the buck”.
The shock waves were widespread.
Money market funds began hoarding cash and stopped rolling over existing positions in
commercial paper and other debt issued by companies, financial institutions, and municipalities.
This dramatically reduced the cash and liquidity available for those entities.
In the final two weeks of September 2008, money market funds reduced their holdings
of commercial paper alone by more than $200 billion.
The runs on money market funds ended only after the Treasury Department took the unprecedented
step of using the Exchange Stabilization Fund to guarantee more than $3 trillion in money
market fund shares.
While this step dramatically improved the market, it also put U.S. taxpayers directly
at risk for any money market fund losses.
In the wake of the financial crisis, many have rightfully asked, “Where were the regulators”
and “Why didn’t they do more to address systemic risks?”
Having reviewed this issue closely and methodically since my arrival in 2009, I have come to understand
that money market funds pose such a risk – and others agree.
Current and former regulators of both political parties have raised flags about the risks
posed by money market funds and the need for reform, as has the Financial Stability Oversight
Council.
Two years ago, we at the SEC passed a series measures to increase the resiliency of money
market funds by instituting liquidity standards, reducing maturities, and improving credit
quality – all important reforms, and one of the first significant responses to the
financial crisis by any government regulator.
But while these steps have been widely hailed, I said then, and still believe, that more
needs to be done.
That’s because the incentive to run clearly remains.
And since Congress specifically prohibited the use of the Exchange Stabilization Fund
to again guarantee money market funds, this core part of our financial system is now operating
without a net.
There are several features about money market funds that can contribute to destabilizing
runs:
First, the stable $1.00 share price together with a history of sponsor support has fostered
an expectation of safety.
Based on a staff analysis, since money market funds were first introduced, fund sponsors
have stepped in with their own capital at least 300 times to absorb losses or protect
their funds from falling below $1.
When a sponsor does not or cannot support a fund, investors lose confidence and rush
to redeem.
Second, because an early redeeming shareholder can receive their full $1.00 investors have
an incentive to redeem at the first sign of problems in a money market fund.
Because large, sophisticated institutional investors are more likely to be closely monitoring
investments and can move large sums of money very quickly, the slower moving retail investors
will bear the full loss.
This is what happened with the Reserve Primary Fund.
And, third, if too many investors redeem at the same time, the fund can be forced to sell
securities at fire sale prices, causing the fund to break a dollar and depressing the
broader short term credit market.
This spreads the contagion to other funds.
It is for these reasons that I asked the staff to explore a number of structural reforms,
including two in particular that may be promising.
The first option would require money market funds, like all other mutual funds, to simply
set their share prices based on the market value of the funds’ underlying assets.
That is, to use “floating” net assets values so money market fund share prices are
adjusted day-to-day to accurately reflect the value of its assets.
This would put money market funds on par with all other mutual funds.
Understanding that the “dollar” is important to investors who use this product, a second
option would be to allow money market funds to maintain a stable value as they do today,
but require the funds to maintain a capital buffer to support the funds’ stable values
and to impose restrictions on redemptions.
On many occasions, members of this Committee have appropriately noted the importance of
capital buffers.
Here a capital buffer would increase money market funds’ ability to suffer losses without
breaking the buck and would permit, for example, money market funds to sell some securities
at a loss to meet redemptions during a crisis.
If a large credit event occurred, the buffer could help manage the loss and additional
redemption restrictions or fees could slow the run, possibly supplement the capital,
and dramatically reduce the contagion to other funds and the system.
These ideas and others are the subject of continuing analysis and discussion at the
Commission.
If the Commission were to propose further reforms, there would be an opportunity for
public consideration and comment.
That would trigger a meaningful and informed public debate on this critical issue for the
nation’s investors, taxpayers and the financial system at large.
It is essential that we address this risk now rather than waiting until the middle of
the next crisis.
Thank you.
And I would be pleased to answer any questions.