An Evaluation of Money Market Fund Reform Proposals

Transcription

1 An Evaluation of Money Market Fund Reform Proposals Samuel G. Hanson, David S. Scharfstein, and Adi Sunderam Discussant: Patrick McCabe Board of Governors of the Federal Reserve System International Banking: Microfoundations and Macroeconomic Implications De Nederlandsche Bank and the International Monetary Fund June 12, 2014 Note: The views expressed here are mine and do not necessarily reflect those of the Federal Reserve Board or its staff. Evaluation of MMF reform proposals 1

2 Introduction Hanson, Scharfstein, and Sunderam (HSS) provide: (1) Excellent overview of the debate over money market fund (MMF) reform in the U.S. What MMFs are, what they do Why they put financial system at risk Market failures at issue (2) Assessment of reform options and recommendations Recommended option: Capital for MMFs Some support for minimum balance at risk (MBR, a form of redemption restriction) Other options insufficient to meet reform goals Evaluation of MMF reform proposals 2

3 Introduction, cont d Broadly speaking, I think HSS get the story right. What I ll do: Provide a slightly different perspective on market failures at issue Suggest a framework for thinking about reform options Emphasize the problematic role of sponsor support for MMFs Not really discussed in HSS List some additional pros & cons regarding capital Give a brief introduction to the MBR Warn that our discussion here of what s best may miss the mark U.S. SEC proposals for MMFs are heading in a different direction. Evaluation of MMF reform proposals 3

4 Market failures HSS identify four market failures (1) MMF investors can redeem shares on demand Redeeming investors don t bear full economic costs of runs (2) Implicit government guarantees (3) Spillovers across funds Investors, managers of any individual MMF don t bear full economic costs (4) Externalities lead to excessive short-term funding, financial fragility. I ll offer some additional perspective on (1) and (2). Evaluation of MMF reform proposals 4

5 Market failures Market failure #1. MMF investors can redeem shares on demand This is a feature of all mutual funds! But redemptions on demand from stock mutual funds not viewed as source of systemic risk. Another way to look at the problem provides a useful framework for considering reform options... Evaluation of MMF reform proposals 5

6 Reform ideas: Conceptual framework MMFs offer an inherently unstable combination of features Stable net asset value 1. Floating net asset value Yield paid to investors > risk-free rate (portfolios risky, illiquid) 2. Portfolio restrictions (e.g., hold only Treasury securities) 3. Capital requirement (reduces yield) Redemptions on demand 4. Restrictions on redemptions that are always in place Meaningful reforms will take something away. Evaluation of MMF reform proposals 6

7 Market failures, cont d Market failure #2. Implicit government guarantees Implicit government support is part of the problem Unprecedented interventions in 2008 were critical in stopping run on MMFs But such support is part of a larger problem that s not discussed in HSS: Uncertainty about who actually bears the risks in MMF portfolios Contractually, MMF shareholders do, but... Evaluation of MMF reform proposals 7

8 MMF sponsors almost always absorb losses Since rules for MMFs first adopted in 1983: Instances in which MMF shareholders have borne losses: 2 Community Bankers U.S. Government MMF, 1994 Reserve Primary Fund, 2008 Instances in which sponsors have borne losses: >200 ( Sponsors are asset management firms and their affiliates) In 2008, at least 29 MMFs had losses >0.5% of assets Sponsors absorbed all losses in 28 of them That one exception (Reserve) made all the difference... Evaluation of MMF reform proposals 8

9 Daily net flows to prime money market funds and Libor-OIS spread, August-October 2008 Basis points 360 Billions of dollars Lehman bankruptcy Reserve breaks the buck Treasury guarantee, AMLF announced One-month Libor-OIS spread (left axis) CPFF Announced Net flows to prime MMFs (right axis) Institutional Retail 8/26 9/2 9/8 9/12 9/18 9/24 9/30 10/6 10/10 Source for MMF flows: Investment Company Institute, imoneynet, and author s calculations. For Libor-OIS spread: Bloomberg, FRBNY Evaluation of MMF reform proposals 9

10 Sponsor support and systemic risk Sponsor support is inherently uncertain No commitment (would force consolidation) No transparency, oversight, resource requirements, etc. Sponsor support does help smooth through idiosyncratic events But may exacerbate crises Uncertainty at such times is not helpful Expectations can transmit stress between sponsors and their off-balance-sheet MMFs Investors fled MMFs with troubled sponsors in 2008 (McCabe 2010) Policy question: Are asset managers themselves systemically important? Evaluation of MMF reform proposals 10

11 Potential options and HSS s assessments 1. Floating net asset value: Insufficient 2. Portfolio restrictions: Not discussed HSS focus is on shoring up prime MMFs 3. Capital requirement: Recommended option 4. Restrictions on redemptions Some support for Minimum balance at risk (MBR) HSS note similarities to capital Below, I ll discuss options #3 and #4. Evaluation of MMF reform proposals 11

12 Capital for MMFs HSS argue that a capital buffer of 3-4 percent: Could reduce likelihood of losses for MMF shareholders from 1.1% to 0.1% per fund-year Costs Reduced yield paid to MMF investors: Just 5 bps Benefits Reduced ex post incentive for investors to run Reduced ex ante incentive for MMFs to take excessive risks Evaluation of MMF reform proposals 12

13 Capital: Some perspective on HSS calibration MMFs with buffer as calibrated may still be quite risky Buffer reduces risk of losses by 90% Historically, sponsor support has absorbed more like 99% of losses Allows 1 fund to blow up about every 5 years Related point: Costs (5 bps) seem low An intuitive benchmark for comparison: Spread between prime MMFs and Treasury-only MMFs Averaged roughly 30 bps before compression of money market yields. Evaluation of MMF reform proposals 13

14 Yield Premiums for Prime MMFs vs. Treasury MMFs Monthly Gross yield premium Net yield premium (after fees) Basis points Average net yield premium, (34 bps) 50 June Source: imoneynet. Note: Calculations based on institutional MMFs only Evaluation of MMF reform proposals 14

15 Capital: Some caveats Capital reduces investors incentives to run But strong incentives may remain Payoffs very asymmetric if fund is at risk Notably, mitigation of banks risk does not rely solely on capital. All potential sources of capital raise complications (1) Sponsors: Their management of risks (given their implicit liabilities) hasn t inspired confidence. (2) Purchase of standby support from a financial institution. But does that help address systemic risk? MMFs and FIs likely to face stress simultaneously. (3) Subordinated share class (capital raised in markets) has much promise But not straightforward to implement (see Appendix). Evaluation of MMF reform proposals 15

16 The minimum balance at risk (MBR) McCabe, Cipriani, Holscher, and Martin (2013) Each MMF investor would have a minimum balance For example, 3-5% of average holdings over past 30 days MBR has little effect on daily transactions in the fund No effect as long as investor s remaining balance exceeds MBR But redemptions of the MBR itself are delayed for 30 days Investor leaves something behind in case there s trouble When an investor redeems non-mbr shares, a portion of her MBR is subordinated Would absorb losses before other MMF shares do But only if the fund breaks the buck and closes Can create a disincentive to redeem in a crisis Evaluation of MMF reform proposals 16

17 Some relative advantages of capital and the MBR Capital advantages Potentially more efficient risk sharing Could displace sponsor support entirely Subordinated share class aligns incentives well. MBR advantages Creates disincentive to redeem in a crisis An MBR may be more effective in slowing redemptions than a capital buffer of the same size. Much simpler to implement than subordinated share class. One promising approach: Combine capital and an MBR... Evaluation of MMF reform proposals 17

18 A Reality Check In June 2013, the U.S. SEC proposed two options for reforms: Option #1: A floating NAV for institutional prime MMFs HSS and others suggest this would have only modest benefits Option #2: Conditional ( standby ) fees and gates If an MMF s weekly liquid assets fall below 15% of assets, its board can: Impose redemption fee of 2% (the default option), or... Impose a lower fee, halt all redemptions, permanently close, or do nothing. Problem: Early redeemers can still shift risks to others Creates preemptive run risk (Cipriani, Martin, McCabe, Parigi, 2014) May make MMFs less stable. Evaluation of MMF reform proposals 18

19 Conclusions HSS provide a very nice overview of the policy challenges posed by MMFs Their support for capital-based solutions generally makes sense It would be helpful to include: More nuanced discussion of pros and cons of capital Clearer description of alternatives (MBR) A reality check: We may differ over the relative benefits of capital and other options Those concerns are small relative to (my) concerns about some changes in MMF rules that may be more likely. Evaluation of MMF reform proposals 19