A number of reform proposals are being considered, including elimination of stable NAVs and capital buffers (possibly combined with redemption restrictions). These reforms would be in addition to new regulations adopted by the SEC in early 2010, which require MMFs to hold more liquid, higher quality and shorter maturity assets, allow MMFs to suspend redemptions under certain conditions, and require more disclosure of MMF portfolio holdings and their value. The MMF industry has argued that these reforms are sufficient to ensure MMF safety.9While these reforms may, in fact, be helpful in reducing portfolio and funding risk, SEC Chairman 8Kacperczyk and Schnabl, op. cit. 9See, for example, “Response to Reported SEC Money Market Funds Proposals,” Investment Company Institute, February 17, 2012.
6Mary Shapiro is right to point out that more needs to be done.10While it is desirable to have MMFs hold more liquid securities to buffer against large redemptions, it is often difficult for regulators to identify assets that will continue to be liquid during a liquidity crisis. Indeed, even securities backed by high quality collateral became illiquid during the financial crisis in 2008.11Moreover, the requirement that MMFs hold shorter maturity securities, while potentially enhancing the safety of MMFs, may actually come in conflict with the objectives of other regulatory initiatives to get banks to be less reliant on short-term, wholesale funding.12Additional reforms are also needed because a number of the tools that the government used to support money markets and stabilize MMFs are now more restricted or unavailable. In particular, the Emergency Economic Stabilization Act of 2008, the legislation that created the Troubled Asset Relief Program, outlaws the use of Treasury’s Exchange Stabilization Fund to guarantee MMF shares as it did in September 2008. And programs that the Federal Reserve and FDIC introduced to stabilize money markets during the crisis would now require either executive branch or Congressional approval.13Some might argue that without these emergency supports, moral hazard will be reduced and, as a result, MMFs and their shareholders will take less risk. But the response of MMFs and their shareholders to the Eurozone sovereign debt crisis suggests otherwise. The two main types of reform proposals are (i) replacement of the stable NAV structure with a floating NAV structure; (ii) various forms of capital buffers. The capital buffer proposals include: requirements that sponsors put their own capital at risk; creation of two shareholder classes, one subordinate to the other; and redemption holdbacks that are put at risk when shareholders redeem their shares. Floating NAV Proposal As noted, above stable NAVs exacerbate run incentives when MMFs get in trouble because early redemptions are made at the $1 share price even if the market-value NAV is less than $1. There are a number of ways in which a floating NAV structure would help promote MMF stability.