[Senate Hearing 112-740]
[From the U.S. Government Publishing Office]







                                                        S. Hrg. 112-740


            PERSPECTIVES ON MONEY MARKET MUTUAL FUND REFORMS

=======================================================================

                                HEARING

                               before the

                              COMMITTEE ON
                   BANKING,HOUSING,AND URBAN AFFAIRS
                          UNITED STATES SENATE

                      ONE HUNDRED TWELFTH CONGRESS

                             SECOND SESSION

                                   ON

    EXAMINING THE HEALTH AND STABILITY OF MONEY MARKET MUTUAL FUNDS

                               __________

                             JUNE 21, 2012

                               __________

  Printed for the use of the Committee on Banking, Housing, and Urban 
                                Affairs



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            COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

                  TIM JOHNSON, South Dakota, Chairman

JACK REED, Rhode Island              RICHARD C. SHELBY, Alabama
CHARLES E. SCHUMER, New York         MIKE CRAPO, Idaho
ROBERT MENENDEZ, New Jersey          BOB CORKER, Tennessee
DANIEL K. AKAKA, Hawaii              JIM DeMINT, South Carolina
SHERROD BROWN, Ohio                  DAVID VITTER, Louisiana
JON TESTER, Montana                  MIKE JOHANNS, Nebraska
HERB KOHL, Wisconsin                 PATRICK J. TOOMEY, Pennsylvania
MARK R. WARNER, Virginia             MARK KIRK, Illinois
JEFF MERKLEY, Oregon                 JERRY MORAN, Kansas
MICHAEL F. BENNET, Colorado          ROGER F. WICKER, Mississippi
KAY HAGAN, North Carolina

                     Dwight Fettig, Staff Director

              William D. Duhnke, Republican Staff Director

                       Charles Yi, Chief Counsel

                     Laura Swanson, Policy Director

                     Dean Shahinian, Senior Counsel

                 Jana Steenholdt, Legislative Assistant

                 Levon Bagramian, Legislative Assistant

                 Andrew Olmem, Republican Chief Counsel

                Mike Piwowar, Republican Chief Economist

            Dana Wade, Republican Professional Staff Member

                       Dawn Ratliff, Chief Clerk

                     Riker Vermilye, Hearing Clerk

                      Shelvin Simmons, IT Director

                          Jim Crowell, Editor

                                  (ii)












                            C O N T E N T S

                              ----------                              

                        THURSDAY, JUNE 21, 2012

                                                                   Page

Opening statement of Chairman Johnson............................     1
    Prepared statement...........................................    26

Opening statements, comments, or prepared statements of:
    Senator Shelby
        Prepared statement.......................................    26

                               WITNESSES

Mary L. Schapiro, Chairman, Securities and Exchange Commission...     1
    Prepared statement...........................................    27
Nancy Kopp, Treasurer, State of Maryland
    Prepared statement...........................................    32
Paul Schott Stevens, President and Chief Executive Officer, 
  Investment Company Institute
    Prepared statement...........................................    43
J. Christopher Donahue, President and Chief Executive Officer, 
  Federated Investors, Inc.
    Prepared statement...........................................   110
Bradley S. Fox, Vice President and Treasurer, Safeway, Inc.
    Prepared statement...........................................   123
David S. Scharfstein, Edmund Cogswell Converse Professor of 
  Finance and Banking, Harvard Business School
    Prepared statement...........................................   126

              Additional Material Supplied for the Record

Prepared statement submitted by the Financial Services Institute.   137
Letter submitted by Michele M. Jalbert, Executive Director--
  Policy and Strategy, The New England Council...................   140
Prepared statement submitted by Jeffrey N. Gordon, Richard Paul 
  Richman Professor of Law and Co-Director, Center for Law and 
  Economic Studies, Columbia Law School..........................   143

                                 (iii)

 
            PERSPECTIVES ON MONEY MARKET MUTUAL FUND REFORMS

                              ----------                              


                        THURSDAY, JUNE 21, 2012

                                       U.S. Senate,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.
    The Committee met, pursuant to notice, at 10:04 a.m., in 
room SD-538, Dirksen Senate Office Building, Hon. Tim Johnson, 
Chairman of the Committee, presiding.

           OPENING STATEMENT OF CHAIRMAN TIM JOHNSON

    Chairman Johnson. I call this hearing to order. Today we 
will examine the health and stability of money market mutual 
funds, the impact of 2010 reforms, and the potential positive 
and negative consequences of additional proposed reforms from 
the perspectives of the industry's regulator, the industry 
itself, users of the industry's products, and an academic 
expert. I look forward to hearing the testimony and 
recommendations as the Committee continues its oversight of the 
financial markets.
    Because we are anticipating a series of 11 votes starting 
in an hour, we are going to forgo opening statements from the 
Committee's Members in order to begin the questioning of our 
witnesses. I will remind my colleagues that the record will be 
open for the next 7 days for opening statements and any other 
materials you would like to submit. I will also ask everyone to 
stick to 5 minutes for your questions.
    On today's first panel we have the Chairman of the 
Securities and Exchange Commission, Chairman Mary Schapiro. 
Chairman Schapiro, please begin your testimony.

    STATEMENT OF MARY L. SCHAPIRO, CHAIRMAN, SECURITIES AND 
                      EXCHANGE COMMISSION

    Ms. Schapiro. Chairman Johnson, Ranking Member Shelby, and 
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 percent of those funds' assets. It was one of several 
destabilizing events during the crisis.
    To meet their customers' 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 2 
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 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 of 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 is 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 of money market funds that can 
contribute to destabilizing runs. First, the stable $1 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, investors have an incentive to redeem at the 
first sign of problems in a 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 and small 
businesses will bear the full loss.
    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 $1 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 fund's underlying 
assets. But 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. Of course, if the 
Commission were to propose 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 am, of course, pleased to answer your 
questions.
    Chairman Johnson. Thank you, Chairman Schapiro.
    We will now begin the questions. Will the clerk please put 
5 minutes on the clock for each Member's questions?
    Chairman Schapiro, as a result of the 2010 reforms, funds 
now publish the assets they hold in their portfolios. What does 
the SEC know about money market funds that they did not know 
before the crisis? How has this new information informed the 
SEC's views on the risk of money market funds?
    Ms. Schapiro. Senator, I would say that the transparency 
initiatives that the SEC undertook in this connection have been 
extremely useful to us in monitoring the risks that money 
market funds are taking. I will also say anecdotally that every 
morning when I pick up the newspaper and read about an 
earthquake in Japan or problems in European financial 
institutions, the first question I ask our staff is: What is 
money market fund exposure to these incidents and to these 
institutions?
    What the data has done is it has given us a window into 
those exposures in a much more granular way, but it also helps 
us understand the risks that exist within fund portfolios. We 
have, in fact, hired a former money market fund portfolio 
manager to help us work through this data.
    I will say, we have noticed some interesting things, such 
as some fund managers are taking on significantly greater risk 
than others, although all their share prices are still priced 
at $1. We have also learned that while most funds significantly 
reduced their exposures to European banks in light of all the 
problems in the eurozone, some funds did not. These funds were 
actually able to capture higher yields, which is very enticing 
to investors but, again, shows you that the $1 share price can 
be a little bit misleading.
    The risks that funds are taking are not prohibited by our 
rules, but it is very important, obviously, for us to have a 
good handle on what those risks are. So we look at the data 
very carefully, and we worry about some of it.
    Chairman Johnson. Which one or two provisions in the 2010 
reforms do you believe have been most beneficial? What analysis 
has the SEC conducted on the full impact and effectiveness of 
the 2010 reforms? And has such analysis informed your view on 
what worked well?
    Ms. Schapiro. Sure. Well, of course, we have studied the 
2010 reforms very carefully. I would say from my perspective, 
the most valuable reforms have been the liquidity 
requirements--the requirement for 10 percent daily liquidity 
and 30 percent weekly liquidity, which are, in fact, exceeded 
on average by funds. But those have been the most helpful in 
meeting redemptions, particularly high numbers of redemptions 
that we saw, for example, this past summer.
    We have analyzed the 2010 reforms carefully. We believe 
they have served their purpose quite well. They do not solve 
for the problem we are most concerned with right now, which is 
the potential for a money market fund to suffer a severe loss 
as a result of a credit event and not be able to absorb that 
loss, and the propensity for there to be runs on money market 
funds. But that said, we think the 2010 reforms were extremely 
positive, and if we put out a release recommending further 
reforms, we will include in that a careful analysis of the 2010 
reforms and why we believe we need to go further.
    Chairman Johnson. There are pros and cons with any policy 
proposal. What would be the impact of additional reforms such 
as floating net asset value, capital buffer, or redemption 
restriction on those who use and rely on money market funds, 
including municipalities, companies, and retail investors, if 
implemented? And do you agree with some who have suggested that 
additional reforms may cause investors to move assets out of 
the money market funds?
    Ms. Schapiro. Well, Senator, that is a question that I 
could answer over a very long period of time, but I think 
clearly additional reforms in this area will have costs 
associated with them, and we would intend in our release to 
fully analyze not just operational administrative costs, which 
could come from systems programming or other kinds of changes, 
but also competitive issues and opportunity costs and the full 
range of costs and benefits.
    But I believe the costs would be far, far outweighed by the 
benefits of forestalling another potentially devastating run, 
as we saw in 2008 when Reserve broke the buck. We will also try 
to measure the 2008 costs, but they are the costs of damaged 
investor confidence. They are the costs of funds frozen in 
order to liquidate and investors not having access to their 
accounts during that period. They are the costs of a short-term 
credit market freezing up and public companies and others not 
being able to issue commercial paper or have their commercial 
paper rolled over. They are the costs of small businesses and 
individuals not being able to access their cash management 
accounts and make payrolls or tuition payments.
    The implications of another run for our economy are very 
broad and very deep, and so those are costs we need to take 
into account as well as the costs, of course, of any proposed 
changes, whether it is floating NAV or capital.
    Chairman Johnson. Senator Shelby.
    Senator Shelby. Thank you.
    Chairman Schapiro, in your written testimony, you mention, 
and I will quote you, ``runs with potential systemic impacts on 
the financial system'' as a justification for additional money 
market fund regulation. Has the Financial Stability Oversight 
Council designated any money market funds or activities as 
``systemically important''?
    Ms. Schapiro. Senator, as you know, in the annual report of 
the Financial Stability Oversight Council, money market funds 
were discussed at length as a weakness and potential systemic 
risk for the U.S. financial system. The FSOC has not designated 
any institutions at this point as systemically important 
financial institutions.
    Senator Shelby. Yesterday the Wall Street Journal reported 
that a new SEC study has found that money market mutual funds 
received financial support from their sponsors more than 300 
times since the 1970s, and that is about 100 more times than 
previously reported. Did the Commission, Madam Chairman, review 
or approve this study? And if so, could you provide a copy of 
the study to this Committee? And how many times, if I could 
add, have money market funds required sponsor support since the 
2010 reforms? Is that too much? That is a lot.
    Ms. Schapiro. It tests my ability to remember, but I hope 
that you will remind me of any pieces of this that I have 
forgotten.
    Senator, the staff did a tabulation, essentially--not 
really a study--a tabulation of occasions where sponsor support 
has been given to money market funds. It does not even include 
all kinds of sponsor support, so I actually believe that the 
number may be conservative. But essentially it is a tabulation 
of many instances where people came to us in order to get 
authority to do sponsor support because what they wanted to do 
was an affiliated transaction, which would be a violation of 
the SEC rules.
    I would be more than happy to provide the information to 
the Committee. As I said, it is likely a conservative number 
because those instances that came to the Commission staff's 
attention because relief was sought or we were notified about 
the support that was given.
    I believe that Moody's reported a number somewhere in the 
vicinity of 200, and I do not know exactly what data looked at 
and over what period of time. I know our staff reviewed 
everything back to the inception of money market funds in the 
1970s.
    I will say, just as an example that our staff may have had 
a different baseline at Moody's, that Moody's reported that 
during the financial crisis, 62 money market funds required 
support from their sponsors, but they looked only at the 100 
largest funds as an example. Our staff looked at everything 
back to the inception of money market funds in the 1970s.
    Senator Shelby. Madam Chairman, did the SEC work with the 
Federal Reserve in developing the 2010 money market fund 
reforms? And if so, would you explain to us the Fed's 
involvement, if any?
    Ms. Schapiro. Senator, I would be happy to supplement the 
record with the specific but I am not sure to what extent the 
staff consulted with or talked with the Federal Reserve Board 
staff with respect to the 2010 reforms. They may well have. I 
just do not know the extent of it.
    Senator Shelby. Is the SEC currently working with the 
Federal Reserve in developing further reforms?
    Ms. Schapiro. Yes, our staffs have had lots of 
conversations about the potential reforms.
    Senator Shelby. OK. Chairman Schapiro, multiple Fed 
officials have included discussions of the risks posed by money 
market funds in recent speeches on shadow banking. Are money 
market funds so-called shadow banks?
    Ms. Schapiro. I am not a big fan of the expression ``shadow 
banks.'' I would say money market funds----
    Senator Shelby. How do you define it, too, right?
    Ms. Schapiro. Right, exactly. I would say that money market 
funds are hugely important and popular investment products in 
our economy, and they are important for millions of investors, 
and they have generally been well and responsibly managed. So 
this is not in any way about ``shadow banks'' or negative 
connotations. This is about my belief that their structure 
presents systemic risk that, as Chairman of the SEC, I think it 
is important we talk about and debate openly and publicly.
    Senator Shelby. Should the Fed be the primary regulator of 
money market funds?
    Ms. Schapiro. I think the SEC is a fine regulator of money 
market funds. I think they are at the end of the day--and this 
is part of what is lost in this discussion--investment 
products. And the SEC is truly the Federal Government's expert 
on investment products.
    The confusion or the complication is that their value does 
not fluctuate like investment products can, should, and do 
because we have the fiction of the stable net asset value.
    Senator Shelby. Thank you, Mr. Chairman.
    Chairman Johnson. Senator Reed.
    Senator Reed. Well, thank you, Mr. Chairman. I want to 
commend you and Ranking Member Shelby for holding this hearing 
because, looking back over the last several years, there were 
many, many issues that had potential dire consequences to the 
financial system which were not examined, even though they were 
small risks, it appeared, but the consequences were, as we 
discovered in 2008 and 2009, extraordinary. So I think this is 
a very, very important topic.
    Let me follow up a question that Senator Shelby posed; that 
is, the Financial Stability Oversight Council has not 
designated a mutual fund as systemically important and subject 
to regulation, but they can do that. Is that correct?
    Ms. Schapiro. I believe that we could designate individual 
funds as systemically important or the activity of maturity 
transformation or credit intermediation or whatever as 
systemically important activities.
    Senator Reed. And that raises a possibility that if the SEC 
does not promulgate a rule which would apply to all mutual 
funds, then the FSOC could pick out, presumably, the largest 
funds and impose restrictions or impose operating procedures on 
them under their authority. Is that a fair estimate?
    Ms. Schapiro. I think that is right. We are working to 
refine what criteria would be used for asset managers in 
designating them as systemically important. But I believe that 
is right.
    Senator Reed. So you could have essentially a system in 
which some are regulated and some are not. I would presume 
anything the SEC did under the Investment Act would apply to 
every mutual fund equally.
    Ms. Schapiro. It would apply to all 2a-7 money market 
funds, and the risk of having some designated and some not 
designated is that, of course, a run can start on a particular 
fund, but the contagion spreads it very quickly across many 
money market funds because, frankly, there is no incentive not 
to run. If you can get your dollar out as an early redeemer, 
why would you take the chance and stay in a fund and 
potentially have to bear the losses?
    Senator Reed. And as you point out, most of the 
institutional investors have the most connectivity to the fund, 
they monitor it on an individual basis, unlike retail 
investors, and they typically under the present rules could 
withdraw their funds at the full NAV, the dollar NAV, and then 
at the end of the line, others might get less. Is that correct?
    Ms. Schapiro. That is right. The tendency is for the losses 
to be concentrated in the remaining or the slower-moving 
shareholders, which are always retail investors and, small 
businesses, not the largest institutions, that are, in fact, 
monitoring their funds.
    Senator Reed. One of the issues that was also raised by 
Senator Shelby is that your testimony about 300 essentially 
situations where the sponsor of the fund stepped in and 
provided capital, which raises the issue, if that is the norm, 
if they have both the intent and the capability of doing that, 
then essentially the funds can police themselves. But that 
raises another issue about both the capacity of these funds and 
their willingness. And perhaps the notion in terms of the--is 
there any consideration to--I know stress-testing of the 
financial companies are popular now, but looking at the 
capacity of funds to be able to support--or sponsors to be able 
to support their funds as something that you would consider?
    Ms. Schapiro. We do have stress-testing now as part of the 
2010 reforms, but it is really stress-testing the portfolio of 
the funds as opposed to testing their capacity and willingness 
to step in and support a fund that is in danger of breaking the 
dollar.
    The real concern about that is not that it is necessarily a 
bad thing to have sponsor support and prevent a fund from 
breaking the dollar. It is that there will come a time when a 
fund will not have, as you say, either the capacity or the 
willingness to step in and support its fund, and investors 
believe that there will be support because history has shown us 
that in hundreds of instances funds have stepped in to do that. 
And, of course, history has shown us that when things got very 
bad, the Federal Government stepped in to do that. So 
experience is trumping their theoretical understanding that 
these are at risk.
    Senator Reed. A final question. I am concerned about the 
impact on municipal participants. Many municipalities, State 
and local governments, use money market funds in a very 
efficient way to manage their case. Are you looking seriously 
at any impact that that could have on municipalities, 
particularly at a time when, frankly, they are all under real 
siege because of the local and national economy?
    Ms. Schapiro. Absolutely. We obviously have concerns. We 
have listened carefully to State and local governments and 
their concerns about money market funds. It has really come 
from two perspectives. One is that they use them as cash 
management vehicles and they need a stable-value product to do 
that, which is one reason we have an option for capital which 
would allow the product to stay a stable-value product. Their 
other concern is whether money market funds will continue to 
exist and be able to buy municipal securities.
    I would note that only about 10 percent of the total 
municipal securities are held by money market funds. It is a 
larger percentage for very short-term paper, but I believe 
money market funds will continue to exist, and they will 
continue to invest in municipal securities. But if a municipal 
treasurer cannot bear the risk of loss of even a penny a share 
in their cash management account, one has to wonder whether a 
money market fund really is the right place for them to be in 
the first instance because they do have that risk if the fund 
breaks the buck.
    Senator Reed. Thank you.
    Thank you, Mr. Chairman.
    Chairman Johnson. Senator Toomey.
    Senator Toomey. Thank you, Mr. Chairman, and I, too, would 
like to thank you for having this hearing, and the Ranking 
Member as well. This certainly is a very, very important topic, 
and I appreciate the chance to have this discussion.
    Thank you, Madam Chairman, for being with us today. In a 
footnote on the first page of your testimony, you acknowledge 
that the views of your testimony are your views and not the 
views of the Commission.
    Ms. Schapiro. That is right.
    Senator Toomey. Is it fair to say that the views that you 
have expressed, in fact, do not represent the majority of the 
Commission?
    Ms. Schapiro. Senator, I guess I would not say that. 
Clearly the Commission as a whole has not joined me in this 
testimony. I think that some would tell you that they still 
have open minds and they want to engage with the document from 
the staff when it is circulated, see what the proposals are, 
see what the cost/benefit and other analyses are. But you are 
right that some of them have expressed their views that nothing 
more needs to be done, that the 2010 reforms were sufficient. 
But I am hopeful that we will have the debate that I think we 
need to have.
    Senator Toomey. I will go out on a limb. It seems to me 
that there is a majority on the Commission that does not share 
your view on this. But we will see how this develops.
    I also want to make the point that the disclosure that 
there were 300 instances in which there was some voluntary 
support succeeded in getting some sensational stories written. 
But the fact that it came without the accompanying analysis and 
without the accompanying data so that people really cannot 
evaluate is it pretty unfortunate because there are--I have 
seen articles in which people leap to conclusions that may not 
be supported by the data. And I would like to drill down a 
little bit into this topic since you have raised this and seem 
to be making this an important basis for suggesting that we 
need some really extraordinary new regulations.
    The Boston Federal Reserve Bank recently cited that there 
were 47 instances of direct support between 2007 and 2010. In a 
recent speech, Federal Reserve Governor Tarullo referred to 
around 100 instances between 1989 and 2003. Moody's reported in 
2010 that there were 181 cases between 1980 and August of 2009.
    My first question is: Is everybody using the same 
definition of what constitutes support?
    Ms. Schapiro. They may not be, and they may not also be 
looking at the entire universe of money market funds, as I said 
earlier.
    Senator Toomey. Right. OK. So could you tell us what is the 
definition that you have used to define an instance of this 
voluntary support that gets you to this count of 300?
    Ms. Schapiro. Yes, I believe we have used, a pretty 
conservative evaluation, looking at those instances for example 
where money market funds came to the staff of the SEC and 
sought authority to essentially violate the affiliated 
transactions rules by making a contribution to the fund. We 
have generally talked about it as buying out distressed paper, 
entering into a capital support agreement, or a letter of 
credit. We did not count renewals of capital support 
agreements, and we did not count other types of potential 
contributions.
    Senator Toomey. OK. So a credit agreement is essentially a 
conditional support. If that was never drawn on, does it still 
count toward the 300?
    Ms. Schapiro. Yes, because it still shows up as a liability 
on the balance sheet.
    Senator Toomey. OK, but there was no credit event that 
occurred, there was no adverse outcome for the fund; it was 
simply an arrangement that was made and was never used in that 
case.
    Another question: Do you distinguish between significant 
and de minimis amounts of support?
    Ms. Schapiro. No, and I do not actually think that it is 
necessarily relevant to distinguish between them. If a fund is 
going to break the buck, it is going to break the buck, and 
capital support is there. It contributes to the understanding 
of investors.
    Senator Toomey. Well, I mean, if it is a de minimis 
arrangement, then it is not clear that the consequence would be 
breaking the buck. But let me ask another question.
    In the event that a sponsor had an agreement to purchase 
securities and the securities eventually paid in full, would 
that still count as one of these instances?
    Ms. Schapiro. Yes, it would.
    Senator Toomey. OK. How about the number of instances since 
the 2010--precisely how many of the 300 occurred after the new 
regulations were imposed in 2010?
    Ms. Schapiro. My understanding is that since 2010 there 
have been three sponsor support occasions that were necessary 
because of the downgrade of a foreign bank. I believe it was a 
Norwegian bank.
    Senator Toomey. But it is very hard for us to evaluate when 
you say ``necessary'' without--I mean, we just went through a 
number of examples in which support is defined in ways that 
certainly would not suggest to me or I think to many people 
that there was any real danger. And my concern is that this is 
the impression that is being created, that these are all 
instances about which we should be very concerned, when, in 
fact, it sounds as though many of them are not terribly 
disturbing.
    Ms. Schapiro. Senator, as I said, I am more than happy to 
provide the background information to you, but I think it is 
also important to note that money market funds come to us and 
ask us for the authority to enter into these arrangements. So 
these are not generated by the SEC. These are generated----
    Senator Toomey. No, I understand. They are heavily 
regulated, and they are forced to come to you for permission to 
do many things. But that does not mean the thing they are 
forced to request permission for are necessarily disturbing or 
evidence that there is a problem here.
    So you will give us public release of all the data and the 
analysis that accompanied it. When do you expect we would be 
able to get a chance to look at that?
    Ms. Schapiro. I would endeavor to get it to you as quickly 
as possible, in the next couple weeks.
    Senator Toomey. OK. I just would like to make the general 
point and just wrap up my time. Your testimony, which I read 
closely, in my view you are portraying an industry that is 
extremely vulnerable, that has all these risks of runs, and I 
really find that extraordinary in light of the actual history. 
When you think of the way this industry has thrived for 
decades, that have seen so many extraordinary events, serious 
recessions, bouts of inflation, the crash of the S&L industry, 
all kinds of devastating natural disasters, 9/11, all the while 
prior to the financial crisis of 2008 there were thousands of 
bank failures, individual years in which hundreds of banks 
failed, and during all that time one money market fund broke 
the buck. There was no run, there was no contagion, and 
investors got 96 cents out of every dollar.
    Then along comes the financial crisis. It is the worst 
since the Great Depression. Investment banks go down in smoke. 
Commercial banks crumble. An entire industry is wiped out. The 
big wire house broker-dealers no longer exist, all either 
forced to be bought or convert their charter. And while the 
entire financial services sector is virtually collapsing and 
seizing up, the panic that seized this whole sector did, in 
fact, affect some of the money market funds somewhat; one of 
them broke the buck, extraordinary measures were taken. I 
understand all that.
    And then you impose new regulations that you talked about: 
liquidity and maturity and credit enhancement and more 
transparency. And since then, we have had another round of real 
stresses, you know, an ongoing terrible recession, European 
credit crisis, downgrade of the U.S. Government, considerable 
redemption pressure, and not a single problem in this whole 
industry. No one gets in trouble. And now without having had a 
chance to look at this data that you cite and citing the very 
characteristics that have been in place from the very first day 
of this industry, you are telling us that this is a very 
vulnerable industry and there are great threats of a run and 
using that to justify regulations that I think threaten the 
very existence of this industry.
    Chairman Johnson. Senator Menendez.
    Senator Menendez. Thank you, Mr. Chairman. Madam Chair, 
thank you for your service. I am not sure which analysis you 
are referring to that you are going to make public, because I 
had a line of questions about your analysis process, and for 
which reforms are you talking about?
    Ms. Schapiro. Sure. I was asked by Senator Shelby and 
Senator Toomey to provide the background on the 300 occasions 
where there has been capital support provided to money market 
funds.
    Senator Menendez. OK. So my question then is: Have you at 
the SEC studied the impact of the SEC's 2010 changes on money 
markets?
    Ms. Schapiro. Yes, we have. And in the release, if we 
publish one, laying out potential further reforms, we would, of 
course, lay that full analysis out. But I will tell you we 
believe the 2010 reforms worked extremely well for what they 
were designed to do, which is to assure that there is 
sufficient liquidity in money market funds to meet heavy 
redemptions. And as we saw through last summer in Europe when 
there was a period of extraordinary redemptions, they performed 
very well. But even during that 3-week period from June 14th 
on, about $100 billion was withdrawn from money market funds. 
That compares to $300 billion withdrawn from money market funds 
in just a few days after Reserve broke the buck.
    So I would disagree that there was no run. There was 
clearly a run in 2008. The goal here is to not demonize an 
industry. As I said, this is an industry that has performed 
very well, has structural weakness----
    Senator Menendez. I do not want to spend my time with you 
answering Senator Toomey.
    Ms. Schapiro. I am sorry. I apologize.
    Senator Menendez. I appreciate that you want to do that, 
but that is good for Presidential debates.
    [Laughter.]
    Senator Menendez. Let me ask you this: Are you going to 
release the impact of the 2010 changes before you move on to 
your next set of reforms? I mean, I think some of us would like 
to know what in essence those 2010 changes did before you move 
on to a next set of reforms to get a sense here of the impact? 
For example, you know, how much have they reduced systemic 
risk, the 2010 reforms? Have they reduced systemic risk? And if 
so, by how much?
    Ms. Schapiro. We could certainly do that, and as the 
Chairman has said, the record will be open for a period after 
the hearing. We could provide that in the form of a response on 
the record.
    Senator Menendez. OK.
    Let me ask you this: Have you done an analysis of your 
proposed reforms that are coming down the pike that you can 
share with us?
    Ms. Schapiro. Well, that would be in the form of a proposed 
rule recommendation with lots of alternatives and options and 
lots of questions. That would include a compliance cost/benefit 
analysis of the proposed options, floating net asset value or 
capital buffer with redemption restrictions, and also a cost/
benefit analysis compared to what the costs are of a run to our 
economy, and all the alternatives, where money might flow if it 
were to flow out of money market funds as a result of any 
reforms.
    So we have quite a detailed cost/benefit and economic 
analysis in the proposing release.
    Senator Menendez. In that analysis, are you going to define 
the reforms both on safety and soundness but also on whether 
investors will be willing to invest in these funds?
    Ms. Schapiro. Yes, we would look at what the competitive 
impacts might be of any reforms.
    Senator Menendez. And do you believe--I have heard some 
criticism that there is not a wide enough array of options 
being considered.
    Ms. Schapiro. Well as you might recall, the President's 
Working Group in 2010 published a report that laid out more 
than half a dozen options for reform, including capital and 
floating NAV, but also a liquidity facility, converting money 
market funds into special-purpose banks, and there were four or 
five other recommendations there.
    Senator Menendez. Well, I am concerned about the net asset 
value of fluctuation, and that is one that I think is 
problematic, and I think we have written to the Commission, 
along with others, expressing that view.
    How much would capital buffers cost, and how much would 
they reduce systemic risk?
    Ms. Schapiro. Well, it depends on obviously how you 
structure a capital buffer. I think that a quite small capital 
buffer coupled with limitations or fees on redemptions would 
permit you to have a small buffer, and yet require redeeming 
shareholders to bear the loss, some of the loss, some of the 
costs of their redemptions. At the same time, the small buffer 
would allow you to have fluctuations that could be absorbed on 
a day-to-day basis. So we will try to cost out in our release 
what the cost of capital would be.
    Senator Menendez. But right now you cannot tell us how much 
that would reduce systemic risk, what you are proposing?
    Ms. Schapiro. Well, I think that is part of our analysis, 
but I think a capital buffer would allow the money market fund 
to maintain the stable value, as it does today, but support it 
through the absorption of relatively small mark-to-market 
losses that occur without breaking the buck.
    Senator Menendez. Thank you, Mr. Chairman.
    Chairman Johnson. Senator Crapo.
    Senator Crapo. Thank you, Mr. Chairman. And, Chairman 
Schapiro, I want to follow up a little bit on Senator 
Menendez's questions about the analysis that you have made. It 
is my understanding that if money market funds were forced to 
float their net asset value, there is a great concern about the 
fact that the flow of hundreds of billions of dollars of both 
corporate and municipal financing would be severely disrupted.
    Have you or your staff undertaken any studies as to how the 
reforms that you have floated might affect the ability to 
investors to continue to use money market funds as an effective 
cash management tool?
    Ms. Schapiro. Absolutely, part of our analysis is the 
impact on State and municipal governments' use of money market 
funds for cash management, and we understand that many of them 
operate under legal requirements to utilize a stable-value 
product. That is one reason we are proposing alternatives. If 
you need to use a stable-value product, then there is a capital 
alternative that would allow the money market fund to still 
price at $1. But we will look at the cost implications for 
municipalities of both the cash management aspect of money 
market funds but also their capacity to buy State and local 
paper.
    Senator Crapo. But at this point have you reached any 
conclusions as to what kind of disruption might be caused in 
the economy if you--in the development of capital in this 
context?
    Ms. Schapiro. We have obviously had conversations with 
State and local governments. We held a roundtable last year 
where we had participation from State and local governments 
talking about the issues and their concerns. Will they need to 
have additional staff? Will they have to change their programs?
    Senator Crapo. And what conclusions have you come up with 
from those conversations?
    Ms. Schapiro. Well, part of our release is to seek specific 
economic data about what those costs would be and then be able 
to compare those costs against the costs of the potential for a 
run that freezes money market funds, suspends redemptions, and 
gives them no access whatsoever to their cash management 
vehicle.
    Senator Crapo. OK. In April, a committee of the 
International Organization of Securities Commissions issued a 
report on the money market funds that included proposals to 
float the net asset value or imposed other varieties of capital 
buffers. Three of the five SEC Commissioners issued, I think, a 
rare statement that said that that report does not reflect the 
views and input of a majority of the Commission.
    My question is: Who at the SEC did provide the input on 
this report? And were the three dissenting Commissioners 
consulted?
    Ms. Schapiro. The staff works with IOSCO on an IOSCO 
committee that was dealing with these issues. The Commissioners 
did disagree with the conclusions. Those disagreements were 
registered at the highest levels of IOSCO. The paper was 
published prematurely, quite honestly, through a genuine 
miscommunication in the process at IOSCO, before the Commission 
was able to register that there was not a majority of the 
Commission's support. But I should emphasize this was a 
consultative staff paper seeking comment on a broad range of 
potential options.
    Senator Crapo. All right. Thank you.
    Professor James Angel from Georgetown University makes the 
point that it is extremely important to distinguish between a 
destabilizing run and an orderly walk. In a run, apparently, as 
he says, the funds are forced to sell assets at potentially 
distressed prices, potentially destabilizing money markets. In 
a walk, the funds can be used in a normal cash-flow manner from 
maturing assets to meet redemptions.
    Are you focusing on that kind of distinction? Do you agree 
with that distinction in the first place? And do you think that 
the reforms that you are talking about properly take into 
account that kind of distinction?
    Ms. Schapiro. I think the reforms do take into account that 
kind of distinction. Our concern is the propensity to run. Our 
concern is not to keep money market funds in business or to 
limit people's ability to withdraw and move their money from 
fund to fund, but our concern is the destabilizing run such as 
we saw in 2008. And we are very focused on that. We have had a 
number of our staff look at Professor Angel's report. I think 
it contains assertions and conjectures and, frankly, 
qualitative statements, but not the kind of quantitative data 
and analysis that we would expect to include along with our 
reform proposals.
    Senator Crapo. So although you may disagree with his 
analysis, you do agree with the distinction that there is a 
difference between a run and an orderly walk, as the term has 
been used?
    Ms. Schapiro. I think when a fund breaks the buck, it is 
very hard to have an orderly walk because a fund is likely to 
suspend redemptions, which freezes everybody in place, 
including people who need access to their funds for cash 
management purposes--payrolls, tuitions, mortgage payments. And 
so my concern is about the potential to break the buck because 
of the brittleness of the $1 value and that leading to a run.
    Senator Crapo. Thank you.
    Chairman Johnson. Senator Warner.
    Senator Warner. Thank you, Mr. Chairman. Let me also thank 
you and the Ranking Member for holding this hearing.
    I want to go back to some of the comments that Senator Reed 
and Senator Toomey made. You know, I share, Chairman Schapiro, 
your concern that if you have got to have an intervention and 
whether that intervention is de minimis or larger, if it is 
breaking the buck, it has the potential of starting and 
unraveling.
    The interesting thing, though, is that when we look at the 
FSOC, normally we go after the largest systemic important 
institutions. My sense is--and I am anxious to see the data as 
well--that the largest money market funds are probably the 
safest in terms of shoring up if they get into this gray area, 
and it really is the smaller ones, the ones on the fringe that 
may be providing the most threat to the system. And I guess 
this again goes back to--I want to comment a little bit more 
about Senator Reed's questions about--and I know there is not 
an equivalency of some type of stress test or analysis. Could 
you speak to that a little bit more?
    Ms. Schapiro. Sure. I think the stress test is an 
interesting idea, the stress test with respect to the capacity 
to provide capital. I think the problem is if there is going to 
be capital support, it ought to be explicit capital support. 
Investors ought to be able to know that it will be there when 
it is needed, not be left to wonder whether the sponsor is 
still capable of providing that support, or still willing to 
provide that support. And I think that is why my view is that 
we need to move forward with a rule that would require either a 
floating net asset value or a capital buffer coupled with some 
kind of redemption fee or limitation in order to ensure that 
those who redeem early are bearing some of the costs----
    Senator Warner. So in a sense no differentiation between 
those money market funds who have had long, stable relations, 
everybody would be in the same pot, right?
    Ms. Schapiro. Well, I think----
    Senator Warner. And with the capital buffer, if we are 
going to go on the capital buffer, would the capital buffer be 
for, you know, a Lehman-style collapse? Or would the capital 
buffer be just kind of in the normal course to have a small 
reserve here so that if there was something that kind of got 
you near that de minimis cushion?
    Ms. Schapiro. I think one of the----
    Senator Warner. Or would that be part of the review and 
analysis you are trying----
    Ms. Schapiro. Well, that is certainly part of the analysis, 
the Reserve Fund was about a $62 billion fund, but I do not 
believe a household name. They held only about 1.2 percent of 
their assets in Lehman paper, a $785 million investment. When 
they broke the buck, yes, admittedly it was at a time of 
general crisis in the economy, but it spread rapidly to many, 
many other money market funds. And if you read former Secretary 
Paulson's book, he talks about really standing on the edge of 
the cliff, hearing from money market fund managers who just did 
not know what was going to happen to them because redemptions 
were going through the roof. And if they were going to have to 
sell securities into this very depressed market in order to 
meet redemptions, they were going to create this spiraling down 
that would be very, very difficult to stop, which is why 
Treasury did step in and, to the tune of more than $3 trillion, 
guarantee all money market funds.
    Senator Warner. But if you had to put a capital buffer to 
be in place for that level of potential contagion, wouldn't you 
potentially really disrupt this whole----
    Ms. Schapiro. I think a capital buffer to contain that 
level would be prohibitively expensive and probably does not 
make sense, which is why you could have a much smaller capital 
buffer if it is coupled with some kinds of limitations on 
redemptions so that at least the losses are borne by all 
redeemers, not just those who are left at the end of the day.
    Senator Warner. But, again, your notion here on these 
reforms would be systemwide, not with some analysis of those 
funds that are graded stronger versus those that are more on 
the periphery?
    Ms. Schapiro. I think it needs to be explicit. I think 
investors need to understand will the capital be there or will 
it not be there, and a uniform capital requirement or capital 
buffer or NAV buffer has that benefit to it. Just to assume 
that because a sponsor never had to support its money market 
fund in the past means it never will in the future would be 
very concerning to me because, in fact, that is what----
    Senator Warner. Let me just ask one last question. Is there 
any sense of--since you have seen improvements since the 2010 
reforms, have you looked at other things in terms of additional 
liquidity requirements as opposed to some of the reforms you 
are looking at? Are there other ways to get at this protection 
without looking at the two options you have looked at so far?
    Ms. Schapiro. We have. As I said, the President's Working 
Group published a paper that laid out lots of different 
options: a liquidity facility, converting these to bank 
products, special-purpose banks, a two-tiered money market fund 
structure where you would have tighter restrictions on a stable 
value fund and less tight on a floating rate fund. There were 
several other alternatives. We took comment on those. We also 
held a roundtable on those. And we are open--and I should say 
this adamantly--we are open to continuing to discuss options. 
We have had lots of very constructive conversations with 
industry, but I think we have to get at the structural 
weakness, and I am not sure just enhanced liquidity 
requirements going to 50 percent weekly liquidity, for example, 
rather than 30 percent would get us there.
    But, again, if we can put a release out, we can have this 
discussion in far more concrete and specific terms with some 
economic analysis to accompany it.
    Senator Warner. Thank you, Mr. Chairman.
    Chairman Johnson. Senator Bennet.
    Senator Bennet. Thank you, Mr. Chairman, and I thank you 
and the Ranking Member for having the hearing. And, Madam 
Chairman, it is nice to see you again. Thank you for your 
service.
    I have actually lived this as a former school 
superintendent. I have seen the huge importance of money market 
funds to school districts and to municipalities, both for cash 
management but also for financing. And I also saw the 
challenges that arise when there is a run, and it is hair 
raising.
    But I think we need to be really cautious about this 
because I think the costs are potentially very real and very 
large for municipalities, for school districts, for local 
government, and there has been a lot of general talk about that 
today. I wonder, have you done specific analysis yet on the 
potential costs to these local governments?
    Ms. Schapiro. Yes, our release will talk about, to the 
extent we have data on the potential costs to municipalities 
and State issuers, as well as on them and their capacity using 
these vehicles for cash management. But we will also seek 
additional data and input on those very issues. We recognize 
this is not a costless proposition by any means. I spent time 
with a number of members, from Colorado in particular, but 
other States as well, after Reserve broke the buck and I was 
brand-new at the SEC, and those members were frantic because 
their local governments could not access their accounts at 
Reserve.
    Senator Bennet. I was there and I know it, and so having 
lived it, I have seen it, and still I am deeply worried about 
the unintended consequences that might arise here, because what 
I know in our case is that the financing we were able to do 
dramatically improved the conditions for kids in the Denver 
public schools who for the first time actually in our history 
are seeing resources added back to their classrooms, while 
districts around us are having to cut back. And had the 
transaction not been one that we could have done, that would 
not be the case today.
    So I guess my plea as you go forward is one for precision 
and for paying very close attention to what effect this might 
have on liquidity at the local level, not for the 
municipalities themselves, not for the school districts 
themselves, but for the people that we serve in those places.
    Ms. Schapiro. Absolutely. We recognize that these are 
incredibly valuable tools, and our goal is to make them 
stronger and better able to withstand----
    Senator Bennet. I wanted to ask a question that I heard a 
little earlier, maybe in a different way, and it is a hard one, 
sort of, because it asks you to look back. But if you look back 
to--you know, had the Dodd-Frank Act law been in place and had 
the 2010 reforms been in effect 4 years ago, what do you think 
the likelihood is that the Reserve Fund would have broken the 
buck? Is it possible that requirements under Dodd-Frank would 
have reduced the likelihood that Lehman Brothers, in which the 
Reserve Fund was heavily invested, would have been in such 
terrible shape? Would the liquidity requirements and improved 
credit standards in the 2010 reforms have affected the 
wherewithal of the Reserve Fund under such circumstances?
    Ms. Schapiro. I do not know that the 2010 amendments would 
have been enough. I think they have been very valuable. I think 
they have contributed to the resiliency of money market funds. 
But they do not address a sudden credit event that causes a 
loss, which is what we had in Reserve when Lehman declared 
bankruptcy and the paper was valued at zero. Those reforms, 
while they require more liquidity, they require shorter 
maturities, they require higher quality, they do not address a 
sudden credit event. They really do not address or alter the 
incentive a shareholder has to run if they even fear losses 
because there is no penalty to getting out quick. There is a 
real penalty to hanging around, potentially.
    I do not think they address the unfair results that can 
occur when a sophisticated institutional investor gets out 
quickly and losses are concentrated with retail investors or 
retail investors are left in a frozen fund and cannot access 
their liquidity.
    So I do not think they would have been enough, and that is 
really why we are here today.
    Senator Bennet. Thank you, Mr. Chairman.
    Chairman Johnson. Any additional questions for Chairman 
Schapiro can be submitted for the record. You may be excused.
    I will now ask the witnesses of the second panel to quickly 
take their seats. We welcome you and thank you for your 
willingness to testify before this Committee.
    The Honorable Nancy Kopp is the treasurer of the State of 
Maryland.
    Mr. Paul Schott Stevens is the president of Investment 
Company Institute, the national association for investment 
companies.
    Mr. Christopher Donahue is the president, CEO, and director 
of Federated Investors.
    Mr. Bradley Fox is vice president and treasurer of Safeway.
    And, finally, we have with us Professor David Scharfstein, 
the Edmund Cogswell Converse Professor of Finance and Banking 
at Harvard Business School.
    Because we are running short on time, we are going to move 
right to questions of our second panel. Each of our witnesses 
statements will be submitted for the record.
    I will ask the clerk to put 5 minutes on the clock for each 
Member's questions.
    Professor Scharfstein, please describe the causes of the 
run on money fund in September 2008 and the reasons why after 
the 2010 reforms you recommend further reforms to preserve 
financial stability?
    Mr. Scharfstein. Thank you, Senator. The run on the money 
funds in September of 2008 was triggered by the failure of 
Lehman Brothers. Actually, in the months--in the year, 
actually, leading up to the failure of Lehman Brothers, recent 
research shows that not just their Reserve Primary Fund but a 
whole host of other funds took the opportunity to increase risk 
in their portfolios. There were stresses in those markets at 
the time, increased yields on various forms of paper that was 
issued by financial institutions, and those funds increased--
not all but quite a few--the risk of their portfolios.
    And so there was a lot of exposure to risky paper in those 
funds, and so when Lehman failed, there was a run on the 
Reserve Primary Fund. Institutional investors--the run 
basically occurred by institutional investors, not retail 
investors--pulled their funds out.
    The 2010 reforms are desirable. They go some of the way. 
But I would say that they are not enough, and I think if you 
look at the recent experience with the European sovereign debt 
crisis, what we saw was a similar event that happened--not as 
extreme. The run was not as quick. It was more a trot. What we 
saw, though, was, again, funds increasing their risk and their 
exposure to euro zone banks, and when the crisis escalated last 
summer, what we saw was large withdrawals from those funds. 
Those had implications for foreign banks, which are the main 
users of the money funds. They are the main issuers into the 
money funds as the foreign banks. And that created a dollar 
funding problem for them, which spilled over and I think has 
affected the ability of those banks to make loans to U.S. firms 
and other companies that need dollar funding.
    I would also say that the liquidity requirements as part of 
that fund also kind of get in--are at cross-purposes with other 
efforts that are in place to try to get U.S. banks to fund 
themselves in a more long-term basis. If you require money 
funds to hold short-term paper, that means that banks are going 
to be issuing more short-term paper, and part of what we are 
trying to do is get banks to fund themselves in a more stable 
way as well.
    Chairman Johnson. Ms. Kopp and Mr. Fox, what impacts have 
the 2010 SEC reforms had on users of money market funds such as 
State Governments and companies? Ms. Kopp, please begin.
    Ms. Kopp. Thank you, Senator. As you know, the States and 
local governments--and I am here representing 13 organizations 
of State, local, and municipal governments--use money market 
funds for liquidity, for money management, as well as for 
financing. And the fact is that the increased tightening of the 
credit standards, the shortening of the duration, the enhanced 
disclosure of having on the Web site the total portfolio has 
made it more possible for us to compare the sites, to compare 
the funds, and to go where we have to go. But as you know, we 
use these funds for daily liquidity, for managing our money, 
and that is our main concern.
    It has made it simpler. We think they have been very 
important. We think there has not been a lot of time since 2010 
to measure all of the impact. But what the professor called a 
trot and the Senator called a walk, both I think are testament 
to the fact that we have not had runs.
    Chairman Johnson. Mr. Fox, what are your views?
    Mr. Fox. I would agree as well. I think the money market 
funds have been extremely efficient allocators of capital from 
investors to borrowers. In the corporate marketplace, some 40 
percent of all corporate commercial paper is purchased by 2a-7 
money market funds. The improvements and the reforms from 2010 
in liquidity, safety, and transparency have only enhanced the 
role that they play in the marketplace, and, you know, I think 
that is shown with the fact that there are $900 billion 
invested currently in prime money market funds, 2a-7 prime 
money market funds from institutional investors. So they have 
proven very resilient in the face of very serious global market 
turmoil from the European debt crisis.
    Chairman Johnson. Senator Shelby.
    Senator Shelby. Thank you, Mr. Chairman.
    I will direct this question to Mr. Stevens and Mr. Donahue. 
Some have argued that a product that seeks to maintain a stable 
net asset value while investing in instruments that can decline 
in value is essentially maintaining a fiction. Is the stable 
net asset value money market fund a fiction? Mr. Stevens. And 
if it is not, why not?
    Mr. Stevens. It is clearly not, Senator.
    Senator Shelby. OK.
    Mr. Stevens. We have actually done a considerable amount of 
empirical analysis of the variability of funds' net asset 
values per share over extended periods of time. The degree to 
which they fluctuate is really quite marginal. You can look at 
it in periods of stress. You can look at it over long periods 
of time.
    Senator Shelby. Does it depend on what you are investing 
in?
    Mr. Stevens. Well, we invest--you are absolutely right. We 
invest only in the shortest, highest-quality paper that is 
available.
    Senator Shelby. And that is the protection, is it?
    Mr. Stevens. That is what under the structure of Rule 2a-7 
permits funds to keep their net asset value per share with a 
great deal of precision around $1.
    Senator Shelby. Mr. Donahue, do you have any comment?
    Mr. Donahue. We had a hearing back with the SEC, an 
administrative law hearing, in the late 1970s on this exact 
subject, and it was the same issues and the same question. The 
SEC is in effect looking for a redo here. But the reason that 
the NAV is solid at a dollar and not a gimmick or whatever is 
precisely because of the portfolios and the credit work to hold 
the maturity and all of the enhancements that were added in 
2010, like Know Your Customer. So it is a solid thing that has 
gone a great thing for the American public.
    Senator Shelby. Ms. Kopp and Mr. Fox, have the disclosure 
requirements improved your ability to manage cash? And would 
your ability to manage cash, which is very important, be 
further improved if the information was provided in real time 
or near real time?
    Ms. Kopp. Well, if you are talking, Senator, of going to a 
floating rate NAV----
    Senator Shelby. Right.
    Ms. Kopp. ----when you are talking about real time, let me 
just make it clear that, first of all, throughout the country 
there are laws and ordinances, particularly with local 
government, that require a stable-value vehicle. So they would 
have to change all of those laws to pull out--or pull out their 
money.
    Last week, the GFOA, which met--the local finance people 
met in Chicago, and there was a clear consensus, almost 
unanimous, that they would simply be forced to move out, A, 
because of the law; and, B, because their accounting systems 
simply do not allow them to go to that system. So they would 
have to go to banks, presumably, which are less transparent and 
not safe.
    Senator Shelby. Do you agree with that, Mr. Fox?
    Mr. Fox. I think from a systems standpoint, it would be 
very difficult to monitor a floating net asset value from money 
market funds, and corporations would simply not use them as 
investment vehicles. The transparency from the 2010 reforms has 
been very helpful. We look at these portfolios. We understand 
where they are invested, and we are comfortable with the stable 
$1 net asset value.
    Senator Shelby. I will direct this first to Professor 
Scharfstein. What should be done to decrease the expectation of 
another taxpayer-funded bailout of the money market fund 
industry? Is it more capital? And how much capital?
    Mr. Scharfstein. I would say it is more capital, and I 
think that is the proper lens--I think it should be more 
capital. I think that is the proper lens to look at this 
through. You know, there was extraordinary support for these 
funds during the crisis and the Treasury guarantee. You know, 
calibrating the exact amount of capital is difficult. I do not 
think it is going to be nearly as costly as people say. In 
fact, if the industry is correct and there is not that much 
risk in the funds, then having a subordinated share class, as 
has been proposed, should really not be very costly at all.
    Senator Shelby. Is the bigger the fund, the larger the 
fund, the less likelihood of visiting the taxpayers? In other 
words, you have got a lot of small money market funds that 
operate everywhere, and some of them operate very well. But in 
a time of crisis, do the big ones as a result have more 
potential to save themselves than others?
    Mr. Scharfstein. Well, certainly sponsors' support, you 
know, is important, and that can be helpful. But I think clear 
capital that is set aside in advance would be better.
    Senator Shelby. What would you suggest about capital? Have 
you got a figure in mind? We are talking about a lot of money 
out there.
    Mr. Scharfstein. That is right. I think if you had a 
subordinated share class, you know, on the order of 3 percent, 
I do not see that as being particularly difficult to do or 
particularly costly.
    Senator Shelby. Mr. Donahue?
    Mr. Donahue. That just will not work. The math does not 
work. The reason you do not hear proposals----
    Senator Shelby. Tell us why it will not work.
    Mr. Donahue. I will tell you. We have a $2.5 trillion 
industry, and so if you say 3 percent of capital, that is $75 
billion of capital. I do not know where you are going to get 
$75 billion of capital. But assuming you can, that demands a 
return on capital. Our cost of capital is like 11 percent. Let 
us use 10 percent. It is easier numbers. That means you have 
got to earn $7.5 billion to pay for the $75 billion. Where are 
you going to earn that? From the $2.5 trillion in the industry. 
That is 30 basis points. In today's way, it does not work.
    We as an adviser in good times have revenues of 15 basis 
points, so the numbers just do not work.
    Senator Shelby. I understand to some extent the interest of 
people and the use of money market funds. You know, it works 
well. But I also sitting up here as a Senator want to make sure 
that the taxpayers do not have to bail out anybody. We have 
done that. We have been down that road. That is a bad road to 
go down, as you well know.
    Mr. Donahue. Senator the best part of Dodd-Frank is that 
part that says you are not allowed to redo the insurance thing 
for money funds, which we did not ask for and did not want.
    Senator Shelby. Thank you.
    Chairman Johnson. Senator Reed.
    Senator Reed. Thank you.
    Mr. Donahue, implicit in a lot of the questions and in the 
operation of the funds is that the funds are prepared and have 
the capacity to, at least on a temporary basis, go up and 
maintain the dollar NAV. Is that a fair assumption?
    Mr. Donahue. The way I would put it is because of the 
construct of their portfolio, they are able to maintain a $1 
NAV. But if they blow a credit and it is a franchise issue, 
then it is not going to be a $1 NAV. Then you are going to have 
the suspension of redemption and the orderly liquidation of the 
fund. But notice you do not have a run because you suspend the 
redemptions, the people do not run, and you have an orderly 
liquidation, which is not what happened in the Reserve case and 
which was improved in the 2010 amendments.
    Senator Reed. But here is the situation. You have a 
prominent fund that miscalculated, in the case of the 
experience in 2008 where it held assets, Reserve had assets in 
Lehman which were rated, I think, AAA 24 hours before they went 
bankrupt. So, you know, they looked pretty good. And because of 
the notoriety and also, I think, because of the assumption that 
people have that a lot of mutual funds are basically sort of--
you know, their portfolios are fairly similar, that there was 
this run.
    So, I mean, your presumption would be that in a situation, 
which might happen, that one fund could, in fact, break the 
buck, stop redemptions, and that would have no spillover effect 
on the funds. Is that the presumption? I just want to 
understand.
    Mr. Donahue. No. What I am saying is that because of the 
2010 amendments, you will not have a run in the fund that 
breaks the buck because you have got this other----
    Senator Reed. Right.
    Mr. Donahue. Now, what has happened in the 2010 amendments 
is that you have more cash in the system. We are required to 
maintain 30 percent weekly cash when 15 percent went out and 
everybody is maintaining about 40. You have transparency, which 
is the questions you have been asking already. People know what 
is in the portfolio. They know whether you have this stuff. And 
we have a Know Your Customer requirement, which means you have 
got to know who is coming in and who is going out.
    But more important than that, the key is do you have 
liquidity in the system. The problem in 2008 was there was no 
liquidity in the system. And when there was a deviation of net 
asset value in 1994, it was no harm, no foul. Why? Because 
there was liquidity in the system and things could work out. 
But when the marketplace was shut down, you had a problem.
    Senator Reed. But here, again, I think Senator Shelby's 
comments go right to the heart of what our job is. We have to 
contemplate, particularly after 2008, things that seem so far 
removed from the day-to-day practice. There is a possibility, 
given all these rules, that there could be a liquidity problem 
in the overall system, not emanating from what you are doing, 
but, you know, take a case where a European banking system, 
where political and economic problems collide, and liquidity 
starts freezing up, then it is not the question of how much 
liquidity you are holding. You just cannot get access to a 
sufficient liquidity to redeem, not in one fund or any fund.
    Is that a possibility?
    Mr. Donahue. That is a possibility, and specifically it is 
addressed by Congress in Dodd-Frank, which directs the Fed, as 
soon as practicable--I do not think it has been practicable 
yet. They are supposed to come up with rules and regulations to 
govern emergency lending that is supposed to ``add money and 
liquidity to the financial system,'' not allowed to aid an 
individual company or failing financial company, and it has to 
be done in a way where they do not lose money, and it has to be 
exited quickly. P.S., that is exactly what they did with the 
AMLF which money funds back at that time.
    Senator Reed. But that essentially--I mean, we are getting 
to sort of what this all might ultimately rest upon--is the 
Federal Reserve stepping in and declaring that this is not--we 
know you cannot do it for an individual company, but that the 
potential impacts of a failing fund could trigger failures in 
other well-run funds; therefore, we are stepping in and using 
Federal resources to support. Is that, Mr. Stevens--I am just 
trying to figure out, you know, what is the assumption 
underlying----
    Mr. Stevens. Senator, if I might, what Chairman Schapiro's 
testimony invites is to look at all 300 of those events through 
the lens of what happened in September 2008. It is true Reserve 
had a contagion effect on other money market funds, but it had 
that effect in the context of a raging epidemic in the banking 
system. And looking at it from the point of view of 2008, you 
can also look at it from the point of view of 1994. That is the 
only other time a fund broke a dollar. Actually, money fund 
assets grew that month, and the world yawned. It did not have a 
knock-on effect.
    So I would invite you to scrutinize whether it is likely, 
particularly with the enormous natural liquidity in these funds 
today--prime money funds have today $600 billion in assets that 
they can liquidate within a week to meet redemptions. Whether 
we have done what the industry thinks we have to address in any 
reasonable term the kind of crisis that we might meet without--
and, Senator Shelby, I agree with you--without any prospect of 
our going to the taxpayer again, although taxpayers paid 
nothing on that guarantee program, and they made a billion and 
a quarter.
    Senator Reed. But, again, I think your point is extremely 
well taken. You know, we cannot ignore 1994, but we cannot 
ignore 2008. We have to look at both.
    Mr. Stevens. Agreed.
    Senator Reed. We have to assess a probability. And then we 
also have to, I think, probe, as I have tried to do--and thank 
you, Mr. Donahue; you have been extremely helpful--what are the 
underlying assumptions if we get into a 2008. Because in the 
1994 situation, the markets sort of moved forward on their own, 
and we just looked and nodded approvingly. But in the 2008 
situation, I think we have to be very careful of probing what 
are the assumptions, and getting back to Senator Shelby's 
point, if there is one assumption that is worst, worst, worst, 
worst, worst, worst case, 0.000001 probability, the Fed has 
this general authority to come in now and move resources, at 
least we have to have that on the table. I think that has to be 
acknowledged.
    Mr. Stevens. The Fed has on numerous occasions taken steps 
to make sure the commercial paper markets in the United States 
are functioning effectively. That is its job for the future as 
well.
    Senator Reed. I just want to make sure that we all 
understand that it is explicit, it is not implicit, because 
down the road, you know, if the Fed does take a move like this, 
you know, I do not--I think we all want to have said, well, we 
knew we had that authority and this is not one of these 
unauthorized bailouts, et cetera. But thank you. Your testimony 
has been extremely helpful.
    Chairman Johnson. Senator Toomey.
    Senator Toomey. Thank you very much, Mr. Chairman.
    I would like to direct several questions to Mr. Donahue. 
Thanks to all of you for being here today. But the first 
question would be in response to Chairman Schapiro's points.
    You know, one of the central arguments that she seems to be 
making is that the past instances in which sponsors provided 
some degree of voluntary support to their money funds means 
that these funds are not as safe as they appear. I think that 
is one of her central arguments. Could you respond to that 
premise?
    Mr. Donahue. Yes, Senator. We create a lot of funds. I am 
one of 13 kids. I have eight of my own. And we create a lot of 
children, too, and you are forever supporting them. And so the 
idea that you support funds--and you look at any other kind of 
products. People are supporting their products. What are they 
trying to do? They are making independent, voluntary, 
marketplace analysis and judgments about what to do with the 
product.
    So, you know, I do not know anything about the 300 or the 
200. None of that really matters. What matters is that you have 
good, solid people deciding whether or not and what to do to 
help shareholders. And I think that what the support shows is 
the inherent resiliency of the funds. When you have $2.6 
trillion in these funds with no interest and lots of regulatory 
abuse, that is really an accomplishment. And it is because the 
people want the cash management system.
    And if you talk about support in terms of what was done 
that the Chairman was talking about, how about the support that 
every single one is doing 100 percent on waiving investment 
advisory fees in order to keep the funds going during these 
low-interest times?
    So I look at support as something that is not unlike having 
a family. You birthed the fund. Well, what are you going to do 
about keeping it going?
    Now, we also merge funds out of existence. We buy other 
funds and put them out of existence. But, overall, we are 
trying to enhance the relationship with the clients, some of 
whom are at this table, in the way they deal in the 
marketplace.
    Senator Toomey. So would it be fair to say that in many 
instances, these--many of the instances that she is citing are 
really manifestations of the strength of an industry rather 
than weakness?
    Mr. Donahue. They are manifestations of the strength and 
they are manifestations of the judgment people make about why 
to do something. For example, there may be a reputational 
issue. The customers may be somewhat uncomfortable with a name, 
even though it is going to pay off on time and in full. There 
may be questions that you want to improve things. So there 
could be a lot of reasons. You may have individual customers 
that you are trying to deal with. And so there are a lot of 
reasons other than you had to buy the Lehman paper out for 
doing that. And there are different elements to it. But I think 
it shows a strong dynamism in the industry to be able to see 
the variety of moves that people have made to support these 
strong products.
    Senator Toomey. The same question I have also for Mr. 
Donahue is that some have suggested that having a fixed net 
asset value is somehow unfair to investors because investors do 
not really understand and they think that this is really akin 
to a bank deposit and a guaranteed thing. That strikes me as a 
rather surprising argument, but it appears frequently. I think 
a variation on that is in Chairman Schapiro's testimony. What 
is your reaction to that?
    Mr. Donahue. We have 5,000 institutional clients and 
millions of individual investors behind that. Most of our 
institutional investors deal with us in one account. I assure 
you they understand what a money market fund is. And if there 
was any good thing to come out of Reserve Fund, which there 
really was not, the one good thing is they realized that the 
investors bore the loss and there was no bailout of a money 
fund.
    So people understand it. Fidelity has run a good survey of 
their retail base and said they understand what the lay of the 
land is. And I think one of the things about all this 
regulatory noise on money funds has done is re-emphasize what 
we put on the front page of every prospectus and every annual 
report, that these things are not guaranteed, they are not 
backed by the FDIC, and you may lose money.
    Senator Toomey. Thanks very much. Mr. Chairman, I would 
just like to ask unanimous consent to submit for the record a 
statement from the Financial Services Institute.
    Chairman Johnson. Without objection.
    Senator Toomey. Thank you very much.
    Ms. Kopp. Mr. Chairman, could I just add on behalf of many 
of the investors--we do represent millions--we do read the 
prospectus, and we know it is an investment. It is not a 
savings account. And the reforms of 2010 and the experience of 
2008 I think has brought that home very clearly. So I think 
treating us sort of like children is really not appropriate.
    Chairman Johnson. Senator Menendez.
    Senator Menendez. Thank you, Mr. Chairman. I want to be 
succinct. I would have so many questions for all of you, but 
the vote is going to expire that is presently going on. So let 
me concentrate on two, Mr. Donahue, that you raise in your 
testimony which caught my attention as I was reading it. And I 
am going to give you the headings, and I would like you to give 
me the why you make that proposition.
    On page 11 [Page 116 below], you say, ``Reforms currently 
under consideration are fundamentally at odds with the nature 
of money market funds and the needs of their shareholders.'' 
Why?
    Chairman Johnson. Excuse me. My staff is informing me that 
we are all needed on the floor for the first vote. Because of 
this, I will remind my colleagues if they have more questions 
for our witnesses, they can submit them for the record.
    I apologize to panel two that we were unable to finish. I 
want to thank our witnesses for their thoughtful testimony 
today and their cooperation in answering the written questions 
that my colleagues will be sending them.
    This hearing is adjourned.
    [Whereupon, at 11:26 a.m., the hearing was adjourned.]
    [Prepared statements and additional material supplied for 
the record follow:]
               PREPARED STATEMENT OF CHAIRMAN TIM JOHNSON
    Today, we are here to review the current state of regulations 
responsible for providing stability to the money market mutual funds 
and protecting investors. More than 50 million municipalities, 
companies, retail investors, and others use money market mutual funds. 
There are $2.6 trillion invested in these funds, which are often viewed 
as convenient, efficient, and predictable for cash management, 
investment, and other purposes. With Americans so heavily invested in 
these funds this Committee has a responsibility to conduct oversight to 
see to it that the Securities and Exchange Commission is doing its part 
and has the resources and authority necessary to effectively regulate 
this critically important financial market.
    Market uncertainty during the financial crisis in 2008 destabilized 
the money market mutual fund industry, prompting the Treasury 
Department to temporarily guarantee funds' holdings. That 1-year 
guarantee prevented a potential systemic run on the money market mutual 
fund industry.
    In response, the SEC adopted significant new rules in 2010 designed 
to increase the funds' resilience to economic shocks and to reduce the 
risks of runs. The key reforms required funds to shorten maturities of 
portfolio holdings, increase cash holdings, improve credit quality, and 
report their portfolio holdings on a monthly basis.
    The adoption of these rules has no doubt improved investor 
protection, but questions still remain about what risk the funds 
present to investors and the American economy, and whether more action 
needs to be taken to address that risk.
    Some regulators and economists have raised concerns that money 
market funds pose significant risks to financial stability, and have 
argued for further structural changes in addition to the 2010 reforms. 
They have proposed floating the net asset value, requiring a capital 
buffer and imposing redemption restrictions.
    At the same time, some funds and users, including municipalities, 
corporations and retail investors, have urged caution, arguing that 
further reforms should wait until the impact of the 2010 reforms can be 
more fully studied. They have raised concerns that new regulatory 
changes might increase risks or disrupt or damage their operations.
    Recognizing the diversity of views on this topic, today's hearing 
is an opportunity to examine the SEC's current regulation of the funds, 
including the impact of the 2010 reforms, and to better understand 
whether additional regulations are needed.
    Our witnesses today represent many interested parties and a broad 
range of perspectives, including the industry's regulator, the industry 
itself, users of the industry's products, and an academic expert.
    I hope to hear from our witnesses about the health and stability of 
money market funds today, the impact of the 2010 reforms, the potential 
positive and negative consequences of the additional proposed reforms, 
and how funds have performed during recent severe economic events such 
as the European debt crisis.
    I look forward to hearing their testimony and recommendations as we 
continue our rigorous oversight of the financial markets.
                                 ______
                                 
            PREPARED STATEMENT OF SENATOR RICHARD C. SHELBY
    Thank you, Mr. Chairman.
    Today the Committee will hear a range of perspectives on money 
market fund reform.
    Since their introduction 40 years ago, money market funds have been 
an important source of short-term financing for businesses, banks, and 
State and local governments.
    Money market funds have offered investors a low-cost means to 
invest in money market instruments and provided them with an efficient 
cash management vehicle.
    But, unlike other mutual funds, money market funds are permitted by 
the SEC to maintain a stable net asset value (NAV).
    The stable NAV feature of money market funds offers investors the 
convenience and simplicity of buying and selling shares at a constant 
one-dollar per share.
    However, because the market value of the instruments held by the 
funds can decline, the stable NAV gives the impression that money 
market funds are without risk and guaranteed to never ``break the 
buck.''
    Indeed, investment management firms have intervened several times 
with capital contributions and other forms of support to prevent their 
money market funds from breaking the buck.
    According to the SEC, U.S. money market funds received financial 
support from their sponsors hundreds of times before the financial 
crisis. During the crisis, firms provided financial support dozens of 
times.
    One notable exception is the Reserve Primary Fund, which broke the 
buck in September 2008 because of its exposure to Lehman Brothers.
    Shortly thereafter, the Treasury Department and the Federal 
Reserve, concerned about runs on money market funds, put the U.S. 
taxpayer in the position of guaranteeing that no other money market 
fund in the country would break the buck.
    The Treasury Department instituted a temporary guarantee program 
and the Federal Reserve opened emergency lending facilities to help 
money market funds meet their redemption requests.
    These actions have increased the expectation that the Federal 
Government will support the money market industry again with taxpayer 
dollars in times of crisis.
    In 2010, the SEC adopted several rules to reduce the risk of runs 
on money market funds.
    The rules imposed minimum liquidity requirements, higher credit 
quality limits, and shorter maturity limits. The SEC also imposed new 
stress test requirements and disclosure requirements to improve the 
transparency of fund portfolio holdings.
    By all accounts, money market funds, thus far, have been able to 
withstand the ongoing European crisis without any risk of runs.
    For this reason, some say that the SEC's 2010 money market reforms 
are sufficient.
    I look forward to hearing from the two industry witnesses and the 
two treasurers representing users of money market funds on why they 
believe that additional reforms are not warranted.
    Others, including Chairman Schapiro, say that the SEC's 2010 money 
market reforms have not gone far enough.
    I would like Chairman Schapiro to tell us what analysis the SEC has 
done to conclude that additional reforms are necessary, and how the SEC 
determined that the three proposals currently under consideration--a 
floating NAV, redemption restrictions, and a capital buffer--are the 
right solutions for the problems they are intended to solve.
    I also look forward to hearing from Professor Scharfstein regarding 
his academic group's capital buffer proposal.
    The loudest voices advocating additional money market fund reforms, 
however, have come from inside the Federal Reserve.
    Fed Chairman Bernanke, Fed Governor Tarullo, and multiple regional 
Fed Presidents have given speeches in which they raise the issue of so-
called ``structural vulnerabilities'' to highlight the need for 
additional reform.
    Further, according to the minutes of the Financial Stability 
Oversight Council (FSOC) meeting held last February, Fed staff 
participated with SEC staff in a discussion of money market funds.
    Unfortunately, the Fed is not represented in today's important 
hearing and they should be.
    Perhaps, Mr. Chairman, we can leave the record open and give the 
Fed an opportunity to submit testimony for the record. I would be very 
interested in learning what analysis it has done to conclude that 
additional money market reforms are necessary.
    Thank you, Mr. Chairman.
                                 ______
                                 
                 PREPARED STATEMENT OF MARY L. SCHAPIRO
              Chairman, Securities and Exchange Commission
                             June 21, 2012
    Chairman Johnson, Ranking Member Shelby, and Members of the 
Committee: Thank you for the opportunity to testify about the 
Securities and Exchange Commission's regulation of money market funds. 
\1\ The risks posed by money market funds to the financial system are 
part of the important unfinished business from the financial crisis of 
2008. One of the seminal events of that crisis occurred in September, 
after Lehman Brothers filed for bankruptcy and the Reserve Primary Fund 
``broke the buck,'' triggering a run on money market funds and freezing 
the short-term credit markets. Although the Commission took steps in 
2010 to make money market funds more resilient, they still remain 
susceptible today to investor runs with potential systemic impacts on 
the financial system, as occurred during the financial crisis just 4 
years ago. Unless money market fund regulation is reformed, taxpayers 
and markets will continue to be at risk that a money market fund can 
``break the buck'' and transform a moderate financial shock into a 
destabilizing run. In such a scenario, policy makers would again be 
left with two unacceptable choices: a bailout or a crisis.
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     \1\ The views expressed in this testimony are those of the 
Chairman of the Securities and Exchange Commission and do not 
necessarily represent the views of the full Commission.
---------------------------------------------------------------------------
    My testimony today will discuss the history of money market funds, 
the remaining systemic risk they pose to the financial system even 
after the 2010 reforms, and the need for further reforms to protect 
investors, taxpayers and the broader financial system.
Background
    Money market funds are important and popular investment products 
for millions of investors. They facilitate efficient cash management 
for both retail and institutional investors, who use them for 
everything from making mortgage payments and paying college tuition 
bills to the short-term investment of cash received through business 
operations until needed to fund payrolls or pay tax withholding. Money 
market funds bring together investors seeking low-risk, highly liquid 
investments and borrowers seeking short-term funding. With nearly $2.5 
trillion in assets under management, money market funds are important 
and, in some cases, substantial providers of credit to businesses, 
financial institutions, and some municipalities who use this financing 
for working capital needs and to otherwise fund their day-to-day 
businesses activities.
    Money market funds are mutual funds. Like other mutual funds, they 
are regulated under the Investment Company Act of 1940. In addition, 
money market funds must comply with Investment Company Act rule 2a-7, 
which exempts money market funds from several provisions of the 
Investment Company Act--most notably the valuation requirements--to 
permit them to maintain stable net asset values per share (NAV), 
typically $1.00. Under this special rule, money market funds, unlike 
traditional mutual funds, can maintain a stable value generally by 
using an ``amortized cost'' accounting convention, rather than market 
values, when valuing the funds' assets and pricing their shares. The 
rule essentially permits a money market fund to ``round'' its share 
price to $1.00, but requires a money market fund to reprice its shares, 
if the mark-to-market per-share value of its assets falls more than 
one-half of one percent (below $0.9950), an event colloquially known as 
``breaking the buck.''
    The Commission adopted rule 2a-7 in 1983 with the understanding 
that the value of the short-term instruments in which the funds invest 
would rarely fluctuate enough to cause the market-based value of the 
fund's shares to deviate materially from a fund's typical $1.00 stable 
value. Rule 2a-7 limits money market funds' investments to short-term, 
high-quality securities for this very purpose.
    Despite these risk-limiting provisions, money market funds can--and 
do--lose value. When, despite these risk-limiting provisions, money 
market fund assets have lost value, fund ``sponsors'' (the asset 
managers--and their corporate parents--who offer and manage these 
funds) have used their own capital to absorb losses or protect their 
funds from breaking the buck. Based on an SEC staff review, sponsors 
have voluntarily provided support to money market funds on more than 
300 occasions since they were first offered in the 1970s. \2\ Some of 
the credit events that led to the need for sponsor support include the 
default of Integrated Resources commercial paper in 1989, the default 
of Mortgage & Realty Trust and MNC Financial Corp commercial paper in 
1990; the seizure by State insurance regulators of Mutual Benefit Life 
Insurance (a put provider for some money market fund instruments); the 
bankruptcy of Orange County in 1994; the downgrade and eventual 
administrative supervision by State insurance regulators of American 
General Life Insurance Co in 1999; the default of Pacific Gas & 
Electric and Southern California Edison Co. commercial paper in 2001; 
and investments in SIVs, Lehman Brothers, AIG and other financial 
sector debt securities in 2007-2008. In part because of voluntary 
sponsor support, until 2008, only one small money market fund ever 
broke the buck, and in that case only a small number of institutional 
investors were affected.
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     \2\ Forms of sponsor support include purchasing defaulted or 
devalued securities out of a fund at par/amortized cost, providing a 
capital support agreement for the fund, and sponsor-purchased letters 
of credit for the fund. Sponsor support does not include a sponsor 
taking an ownership interest in (i.e., purchasing shares of) a money 
market fund.
---------------------------------------------------------------------------
    The amount of assets in money market funds has grown substantially, 
and grew particularly rapidly during recent years from under $100 
million in 1990 to almost $4 trillion just before the 2008 financial 
crisis. This growth was fueled largely by institutional investors, who 
were attracted to money market funds as apparently riskless investments 
paying yields above riskless rates. By 2008, more than two-thirds of 
money market fund assets came from institutional investors, which could 
wire large amounts of money in and out of their funds on a moment's 
notice. Some of these institutional assets were what are known in the 
business as ``hot money''--assets that would be quickly redeemed if a 
problem arose, or even if a competing fund had higher yields. To 
compete for that money, some money market fund sponsors invested in 
new, riskier types of securities, such as ``structured investment 
vehicles.'' The larger amount of assets in money market funds 
contributed to the likelihood that a credit event would create stresses 
on one or more funds, and that fund sponsors would not have access to a 
sufficient amount of capital to support the funds.
The 2008 Financial Crisis
    Implicit sponsor support as a mechanism to maintain a stable $1.00 
share price increasingly came under strain as the size of money market 
funds grew into a several trillion dollar industry. The Reserve Primary 
Fund broke the buck after it suffered losses its sponsor could not 
absorb. The Reserve Primary Fund, a $62 billion money market fund, held 
$785 million in Lehman Brothers debt on the day of Lehman Brothers' 
bankruptcy and immediately began experiencing a run--shareholders 
requested redemptions of approximately $40 billion in just two days. 
The Reserve Primary Fund announced that it would reprice its shares 
below $1.00, or break the buck.
    Almost immediately, the run on the Reserve Primary Fund spread, 
first to the Reserve's family of money market funds, and then to other 
money market funds. Investors withdrew approximately $300 billion (14 
percent) from prime money market funds during the week of September 15, 
2008. Money market funds met those redemption demands by selling 
portfolio securities into markets that were already under stress, 
depressing the securities' values and thus affecting the ability of 
funds holding the same securities to maintain a $1.00 share price even 
if the other funds were not experiencing heavy redemptions. Money 
market funds began to hoard cash in order to meet redemptions and 
stopped rolling over existing positions in commercial paper and other 
debt issued by companies, financial institutions, and some 
municipalities. In the final two weeks of September 2008, money market 
funds reduced their holdings of commercial paper by $200.3 billion, or 
29 percent.
    Money market funds were (and are) substantial participants in the 
short-term markets--in 2008 they held about 40 percent of outstanding 
commercial paper. The funds' retreat from those markets caused them to 
freeze. During the last 2 weeks in September 2008, companies that 
issued short-term debt were largely shut out of the credit markets. 
Cities and municipalities that rely on short-term notes to pay for 
routine operations while waiting for tax revenues to be collected were 
forced to search for other financing. The few companies that retained 
access to short-term credit in the markets were forced to pay higher 
rates or accept extremely short-term--sometimes overnight--loans, or 
both. All of this occurred against the backdrop of a broader financial 
crisis, which was exacerbated by the growing credit crunch in the 
short-term markets.
    More than 100 funds were bailed out by their sponsors during 
September 2008. But the fund sponsors were unable to stop the run, 
which ended only when the Federal Government intervened in an 
unprecedented manner. In September 2008, the Treasury Department 
temporarily guaranteed the $1.00 share price of more than $3 trillion 
in money market fund shares and the Board of Governors of the Federal 
Reserve System created facilities to support the short-term markets. 
These actions placed taxpayers directly at risk for losses in money 
market funds but eased the redemption pressures facing the funds and 
allowed the short-term markets to resume more normal operations. 
Because the Federal Government was forced to intervene we do not know 
what the full consequences of an unchecked run on money market funds 
would have been.
    The experience of shareholders of the Reserve Primary Fund, 
however, is instructive about the impact of an unchecked run on 
investors. While some observe that shareholders in the Reserve Primary 
Fund ultimately ``lost'' only one penny per share, this ignores the 
very real harm that resulted from shareholders losing access to the 
liquidity that money market funds promise. They were left waiting for a 
court proceeding to resolve a host of legal issues before they could 
regain access to their funds. In the meantime, their ability to make 
mortgage payments, pay employees' salaries and fund their businesses 
was substantially impaired, and Reserve Fund investors were left in a 
sea of uncertainty and confusion. Some of their money is still waiting 
to be distributed.
    The next run might be even more difficult to stop, however, and the 
harm will not be limited to a discrete group of investors. The tools 
that were used to stop the run on money market funds in 2008 are either 
no longer available or unlikely to be effective in preventing a similar 
run today. In September 2008, the Treasury Department used the Exchange 
Stabilization Fund to fund the guarantee program, but in October 2008 
Congress specifically prohibited the use of this fund again to 
guarantee money market fund shares. \3\ The Federal Reserve Board's 
Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity 
Facility (AMLF), through which credit was extended to U.S. banks and 
bank holding companies to finance purchases of high-quality asset 
backed commercial paper (ABCP) from money market funds, expired on 
February 1, 2010. Given the significant decline in money market 
investments in ABCP since 2008, reopening the AMLF would provide little 
benefit to money market funds today. For example, ABCP investments 
accounted for over 20 percent of Moody's-rated U.S. prime money market 
fund assets at the end of August 2008, but accounted for less than 10 
percent of those assets by the end of August 2011.
---------------------------------------------------------------------------
     \3\ See, Emergency Economic Stabilization Act of 2008, Public Law 
110-343, 122 Stat. 3765 131 (``The Secretary is prohibited from using 
the Exchange Stabilization Fund for the establishment of any future 
guaranty programs for the United States money market mutual fund 
industry.'').
---------------------------------------------------------------------------
The 2010 Reforms
    Shortly after I joined the Commission in 2009, I asked the 
Commission's staff to prepare rulemaking designed to address concerns 
about money market funds revealed by the 2007-2008 crisis. The staff, 
with assistance from a report prepared by the money market fund 
industry, quickly identified some immediate reforms that would make 
money market funds more resilient. I am proud of this initial reform 
effort, but it is important to recognize what it did and did not do. 
The initial reforms, adopted and implemented in 2010, were designed to 
reduce the risks of money market funds' portfolios by reducing 
maturities; improving credit standards; and, for the first time, 
mandating liquidity requirements so that money market funds could 
better meet redemption demands. The new reforms also required money 
market funds to report comprehensive portfolio and ``shadow NAV'' 
information to the Commission and the public.
    The 2010 rules made money market funds more resilient in the face 
of redemptions by requiring them to increase the liquidity of their 
portfolios. But the amendments did not (1) change the incentives of 
shareholders to redeem if they fear that the fund will experience 
losses; (2) fundamentally change the dynamics of a run, which, once 
started, will quickly burn through the additional fund liquidity; (3) 
prevent early redeeming, often institutional investors from shifting 
losses to remaining, often retail investors or (4) enable money market 
funds to withstand a ``credit event'' or the loss in value of a 
security held by a money market fund, precisely what triggered the run 
on the Reserve Primary Fund.
    That money market funds were able to meet redemptions last summer 
when the markets were under stress suggests the 2010 reforms have 
helped address the risks they were designed to address. However, the 
reforms were not designed to address the structural features of money 
market funds that make them susceptible to runs, and the heavy 
redemptions of 2011 were (1) substantially less than in 2008, (2) made 
over a longer period of time, and (3) not accompanied by losses in fund 
portfolios. During the 3-week period beginning June 14, 2011, investors 
withdrew approximately $100 billion from prime money market funds. In 
contrast, during the 2008 financial crisis, investors withdrew over 
$300 billion from prime money market funds in a few days. These are 
significant differences. If there had been real credit losses last 
summer, the level of redemptions in some funds could very well have 
forced a money market fund or funds to break the buck, leading to the 
type of destabilizing run experienced in 2008.
    The events of last summer demonstrate that money market fund 
shareholders continue today to be prone to engage in heavy redemptions 
if they fear losses may be imminent. About 6 percent of prime fund 
assets were redeemed during a 3-week period beginning June 14, 2011, 
and one fund lost 23 percent of its assets during that period even 
though the funds involved had not experienced any losses. The incentive 
to run clearly remains in place notwithstanding the 2010 reforms.
Susceptibility to Runs
    Money market funds are vulnerable to runs because shareholders have 
an incentive to redeem their shares before others do when there is a 
perception that the fund might suffer a loss. Several features of money 
market funds, their sponsors, and their investors contribute to this 
incentive.

    Misplaced Expectations. The stable $1.00 share price has fostered 
an expectation of safety, although money market funds are subject to 
credit, interest-rate, and liquidity risk. Recurrent sponsor support 
has taught investors to look beyond disclosures that these investments 
are not guaranteed and can lose value. As a result, when a fund breaks 
a dollar, investors lose confidence and rush to redeem. Not only did 
large numbers of investors redeem their shares from The Reserve Primary 
Fund that held Lehman Brothers commercial paper, they also redeemed 
from other Reserve money market funds that held no Lehman Brothers 
paper, including a Government fund.
    First Mover Advantages. Investors have an incentive to redeem at 
the first sign of problems in a money market fund. An early redeeming 
shareholder will receive $1.00 for each share redeemed even if the fund 
has experienced a loss and the market value of the shares will be worth 
less (e.g., $0.998). By taking more than their pro rata share of the 
assets, these redemptions at $1.00 per share concentrate losses in the 
remaining shareholders of a fund that is now smaller. \4\ As a result a 
small credit loss in a portfolio security, if accompanied by sufficient 
redemptions, can threaten the fund with having to break the buck.
---------------------------------------------------------------------------
     \4\ Assume, for example, a fund with 1,000 shares outstanding with 
two shareholders, A and B, each of which owns 500 shares. An issuer of 
a security held by the fund defaults, resulting in a 25 basis point 
loss for the fund--a significant loss, but not one that is large enough 
to force the fund to break the buck. Shareholder A, aware of a problem 
and unsure of what shareholder B will do, redeems all of his shares and 
receives $1.00 per share even though the shares of the fund have a 
market value of $0.998. The fund now has only 500 shares outstanding, 
but instead of a 25 basis point loss has a 50 basis point loss and will 
have broken the buck. Shareholder A has effectively shifted his losses 
to Shareholder B.
---------------------------------------------------------------------------
    Moreover, early redeemers tend to be institutional investors with 
substantial amounts at stake who can commit resources to watch their 
investments carefully and who have access to technology to redeem 
quickly. This can provide an advantage over retail investors who are 
not able to monitor the fund's portfolio as closely. As a consequence, 
a run on a fund will result in a wealth transfer from retail investors 
(including small businesses) to institutional investors. This result is 
inconsistent with the precepts of the Investment Company Act, which is 
based on equal treatment of shareholders.
    Mismatch of Assets and Liabilities. Finally, money market funds 
offer shares that are redeemable upon demand, but invest in short-term 
securities that are less liquid. If all or many investors redeem at the 
same time, the fund will be forced to sell securities at fire sale 
prices, causing the fund to break a dollar, but also depressing 
prevailing market prices and thereby placing pressure on the ability of 
other funds to maintain a stable net asset value. A run on one fund can 
therefore create stresses on other funds' ability to maintain a $1.00 
stable net asset value, prompting shareholder redemptions from those 
funds and instigating a pernicious cycle building quickly towards a 
more generalized run on money market funds.

    Given the role money market funds play in providing short-term 
funding to companies in the short-term markets, a run presents not 
simply an investment risk to the fund's shareholders, but significant 
systemic risk. No one can predict what will cause the next crisis, or 
what will cause the next money market fund to break the buck. But we 
all know unexpected events will happen in the future. If that stress 
affects a money market fund whose sponsor is unable or unwilling to 
bail it out, it could lead to the next destabilizing run. To be clear, 
I am not suggesting that any fund breaking the buck will cause a 
destabilizing run on other money market funds--it is possible that an 
individual fund could have a credit event that is specific to it and 
not trigger a broad run--only that policy makers should recognize that 
the risk of a destabilizing run remains. Money market funds remain 
large, and continue to invest in securities subject to interest rate 
and credit risk. They continue, for example, to have considerable 
exposure to European banks, with, as of May 31, 2012, approximately 30 
percent of prime fund assets invested in debt issued by banks based in 
Europe generally and approximately 14 percent of prime fund assets 
invested in debt issued by banks located in the eurozone.
Additional Needed Reforms
    The Commission staff currently is exploring 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 buy and sell their shares based on the market value of the funds' 
assets. That is, to use ``floating'' net assets values. Such a proposal 
would allow for public comment on whether requiring money market funds 
to use floating NAVs would cause shareholders to become accustomed to 
fluctuations in the funds' share prices, and thus less likely to redeem 
en masse if they fear a loss is imminent, as they do today. It would 
also treat all investors more fairly in times of stress.
    A second option would allow money market funds to maintain a stable 
value as they do today, but would require the funds to maintain a 
capital buffer to support the funds' stable values, possibly combined 
with limited restrictions or fees on redemptions. The capital buffer 
would not necessarily be big enough to absorb losses from all credit 
events. Instead, the buffer would absorb the relatively small mark-to-
market losses that occur in a fund's portfolio day to day, including 
when a fund is under stress. This 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.
    As described above, many money market funds effectively already 
rely on capital to maintain their stable values: hundreds of funds have 
required sponsor bailouts over the years to maintain their stable 
values. Requiring funds to maintain a buffer simply would make explicit 
the minimum amount of capital available to a fund. Today, in contrast, 
an investor must wonder whether a sponsor will have the capital to 
bailout its fund and, even if so, if the sponsor will choose to use it 
for a fund bailout.
    Limits on redemptions could further enhance a money market fund's 
resiliency and better prepare it to handle a credit event. Restrictions 
on redemptions could be in several forms designed to require redeeming 
shareholders to bear the cost of their redemptions when liquidity is 
tight. Redemption restrictions could be designed to limit any impact on 
day-to-day transactions.
    These ideas and others are the subject of continuing analysis and 
discussion at the Commission. If the Commission were to propose further 
reforms, there will, of course, be an opportunity for full public 
consideration and comment. In addition to a detailed release seeking 
comment on the likely effectiveness and impacts of the proposed 
reforms, the proposal will also include a discussion of their benefits, 
costs, and economic implications.
Conclusion
    In closing, money market funds as currently structured pose a 
significant destabilizing risk to the financial system. While the 
Commission's 2010 reforms made meaningful improvements in the liquidity 
of money market funds, they remain susceptible to the risk of 
destabilizing runs. Thank you for the opportunity to testify on this 
important issue. I am happy to answer any questions that you might 
have.
                                 ______
                                 
                    PREPARED STATEMENT OF NANCY KOPP
                      Treasurer, State of Maryland
                             June 21, 2012
Introduction
    Chairman Johnson, Ranking Member Shelby, and Members of the 
Committee, thank you for providing the National Association of State 
Treasurers (NAST) the opportunity to testify on the issue of money 
market mutual funds (MMFs). It is an honor and a privilege to be here 
today. I am Nancy Kopp, the Treasurer for the State of Maryland and 
chair of the NAST Legislative Committee.
    NAST is a bipartisan association that is comprised of all State 
treasurers, or State finance officials with comparable 
responsibilities, from the United States, its commonwealths, 
territories, and the District of Columbia.
    I appreciate this timely hearing appropriately named ``Perspectives 
on Money Market Reforms'' as I can assure you State Treasurers have a 
unique perspective given their important role within the States of 
ensuring proper cash flow management.
The Importance of Money Market Funds to the States
    MMFs are a vital cash management tool for State Governments, their 
political subdivisions, and their respective instrumentalities, all of 
which rely upon them to manage short-term investments that provide 
ready liquidity, preservation of capital, and diversification of 
credit. There are few options that have the multiple features of 
safety, return, liquidity and stable market history as MMFs and that is 
why so many States and local governments choose this product for their 
short- and mid-term investing and cash management needs. Additionally, 
States rely on MMFs to buy short term securities issued by States, 
local governments, and authorities. MMFs are by far the largest 
purchasers of these bonds, and if capitalization requirements and other 
restrictions put limits on their investment capital their demand for 
these bonds will decrease, and costs to issue these bonds--borne at the 
expense of taxpayers--would rise.
NAST Support for SEC Changes to Rule 2a-7 in 2010
    Before the proposed SEC regulations are discussed, it is important 
to note that NAST is on record supporting the amendments to Rule 2a-7 
adopted by the SEC in 2010. The regulation of MMFs was brought under 
scrutiny by regulators following the Reserve Primary Fund's NAV 
dropping below $1.00, or ``breaking the buck'', during the global 
financial crisis of 2008. The SEC appropriately responded by amending 
Rule 2a-7 which strengthened MMFs by increasing liquidity and credit 
quality requirements, enhanced disclosures to require reporting of 
portfolio holdings monthly to the Commission, shortened portfolio 
maturities, and permitted a suspension of redemptions if a fund has 
broken the buck or is at imminent risk of breaking the buck.
    NAST believes the Commission's amendments to Rule 2a-7 finalized on 
May 5, 2010, have made MMFs more transparent, less subject to interest 
rate risk, more creditworthy and less susceptible to redemption demand 
pressure during periods of stress in the financial markets. However, we 
are concerned that some Commissioners and members of the staff, as well 
as other Federal regulators and officials, have publicly indicated 
support for further amending Rule 2a-7 without taking into 
consideration the effectiveness of the 2010 amendments. Such potential 
changes to Rule 2a-7 that have been discussed recently include 
restrictions on the redemption of MMF shares by investors, requiring 
MMFs to adopt a floating daily net asset value (NAV), and/or mandating 
that MMFs hold levels of capital similar to banking institutions.
    In March 2012 at the NAST Federal Affairs Conference, NAST passed 
its Federal Securities Regulation of Money Market Mutual Funds 
Resolution which is included as an attachment to this testimony. 
Specifically, there are three purported proposals from the SEC that 
cause us concern:
Changing From a Stable NAV to a Floating NAV Feature
    State Treasurers recognize that a floating NAV would increase 
accounting work tremendously because it would require the daily booking 
of the mark-to-market value of each fund. Being able to currently book 
the value of the fund as a dollar in equals a dollar out without having 
to note the daily fluctuations of its worth, is invaluable. When many 
Governments are hard pressed to hire teachers and public safety 
officers, it is difficult to see how States would be able to 
appropriate funds for more accountants to do this work, which in the 
end, would be of no value to the overarching issue as to whether it 
would prevent a run on these funds. If the stable NAV is changed to a 
floating NAV, we will have to look to other investment products to 
avoid unnecessary accounting burdens. It is important to note that a 
floating NAV would have negligible day-to-day changes, but the 
accounting for these changes is significant. In addition, many 
government jurisdictions are required by statute to invest only in 
products with a stable NAV like MMFs. If the SEC changes the NAV to a 
floating feature, these jurisdictions would be forced to find 
alternative investments that are not as attractive as MMFs for a 
variety of reasons discussed in this testimony.
The Importance of Liquidity
    Another important feature of these funds is their liquidity. Often 
State and local governments receive payments that can be placed in a 
fund, sometimes as briefly as one night, because the funds are needed 
in the morning. This feature allows State and local governments to 
place these monies in a safe environment while still earning interest 
for the taxpayers. Often payments come in later in the day and no other 
product offers the ability to make an investment later in the day, 
including bank deposits. It is this key cash management tool, which 
attracts so many Governments--and other businesses--to these funds.
Placing Capital Requirements on Funds
    The SEC is also looking at the possibility of placing capital 
requirements on MMFs to be held against a possible run on MMFs. Again, 
Treasurers are concerned that the additional costs of MMF operations 
could result in lower yields--or eliminate these funds altogether--and 
would push Treasurers into using other less attractive investment 
alternatives. It is also unlikely that placing capital requirements on 
these funds will actually prevent a run on these products, or otherwise 
truly benefit the market.
Placing Redemption Requirements on Funds
    As discussed previously, Treasurers use MMFs to move money in and 
out on a daily basis in order to meet their cash management needs. 
Requirements that would limit the amount that could be withdrawn from a 
Government's MMF account would be highly disruptive. If money is held 
back or delayed, State Treasurers would have to then create a system 
and use precious resources to track these holdbacks and have to plan 
for the future accordingly. If this becomes a requirement, Treasurers 
will seek other investments to find more reliable forms of liquidity. 
Additionally, this could be especially problematic for smaller 
Governments whose investments may not be large enough to buffer these 
requirements, and who need access to the full value of their account in 
order to make various payments, including payroll.
State and Local Governments Organizations Standing Together
    On March 8, 2012, NAST joined 13 other organizations representing 
State and local governments in a joint letter to each of the SEC 
Commissioners expressing concern over potential regulations presently 
being considered. These organizations include the:

    American Public Power Association

    Council of Development Finance Agencies

    Council of Infrastructure Financing Authorities

    Government Finance Officers Association

    International City/County Management Association

    International Municipal Lawyers Association

    National Association of Counties

    National Association of Health and Educational Facilities 
        Finance Authorities

    National Association of Local Housing Financing Agencies

    National Association of State Auditors, Comptrollers and 
        Treasurers

    National Association of State Treasurers

    National Council of State Housing Agencies

    National League of Cities

    U.S. Conference of Mayors

    The letter was intended to make clear to the SEC how vital MMFs are 
for members of the listed organizations who utilize MMFs on a daily 
basis. The cosigners also supported the changes to SEC Rule 2a-7 in 
2010 and would support initiatives that would strengthen MMFs and 
ensure investors are investing in high-quality securities. However, 
these State and local organizations all recognized that if the 
discussed SEC regulations were to require a floating NAV, it very well 
could preclude State and local governments' ability to invest in these 
securities. As the cosigning organizations include issuers of municipal 
securities, a further concern that the SEC regulations would ``dampen 
investor demand for the bonds we offer and therefore increase costs for 
the State and local governments that need to raise capital for the 
vital infrastructure and services.''
    A letter to this Committee, outlining our concerns about possible 
changes to MMFs from the State and local government community, 
including NAST, is also included in this testimony.
Effect on the Municipal Securities Market
    Money Market Mutual Funds are by far the largest purchaser of short 
term municipal debt. If investors no longer use MMFs, then these funds 
will not have the same purchasing power to buy our debt. That would 
create a negative situation for State and local governments--a decrease 
in demand for our debt means the cost of issuing that debt will 
increase, on top of the likely increase in fees that would occur if 
Governments would no longer be able to use MMMFs for their investment 
and cash management purposes.
Finding Alternative Investments if MMFs Are Not Viable
    One question that must be answered is why State Treasurers utilize 
MMFs rather than bank deposits or investing directly in commercial 
paper. First, Treasurers, as financial stewards of their respective 
States, have been able to use the well regulated MMFs to improve 
return. Banks are paying very little on deposits and deposits are only 
insured up to $250,000. First tier commercial paper that is not asset-
backed pays slightly more than deposits, but less than MMFs. Commercial 
paper also has transaction costs, custodial fees, less flexibility, and 
importantly lacks the liquidity of MMFs as it does not have an active 
secondary market. Finally, one critical distinction to be made between 
MMFs and commercial paper is that MMFs allow for greater diversity of 
exposure and lower credit risk. The same cannot be said of commercial 
paper since it is an individual security with risked based on that 
security alone. If, for example, a State had purchased Lehman Brothers 
commercial paper in 2008 as an alternative to MMFs, it would have had 
to absorb the entire loss of that particular holding.
Treasurer Kopp, State Treasurer of Maryland, Utilization of PMMF's
    As Treasurer of Maryland I would like to convey how important MMFs 
are to States that utilize MMF's by showing how MMFs are used in my 
State. The State of Maryland uses MMFs to achieve the most efficient 
liquidity while earning a modest return like most other governmental 
entities throughout the Nation. The State of Maryland averages between 
$250 and $350 million in MMFs deposits on a daily basis for the 
operating fund depending on the fiscal year cycle. The State Debt and 
Lease programs average an additional $100 million invested in MMFs. The 
Maryland Local Government Investment Pool (LGIP) averages between $250 
and $350 million in MMF deposits on a daily basis depending on the 
total size of the pool which varies from $2.5 billion to $3.5 billion, 
again depending on fiscal year cycle and available competing options. 
The Maryland State Retirement System had $1.569 billion of the $36.2 
billion invested in MMFs as of May 31, 2012. Through the years the 
State has relied on MMFs for a safe place to put unexpected deposits 
that arrive late in the day until a more appropriate investment can be 
purchased and for daily liquidity for unexpected outflows or to cover 
failed delivery of expected incoming funds.
    In 2008, the State of Maryland had over $230 million invested in 
The Reserve Primary Fund. As we monitored the economic conditions and 
the Reserve Prime Fund Portfolio, we determined that the risk of the 
Primary Fund was more than we desired. So we transferred our investment 
into the Reserve Government Fund. When the Reserve Primary Fund ``broke 
the buck'' on September 16, 2008, our funds were safely invested in the 
Government Fund. We had read the prospectus and knew that MMFs had the 
option to delay return of investments in dire economic circumstances. 
Therefore, we were prepared to wait for our investment to be returned. 
Our total Reserve Government Fund investment was returned January 21, 
2009, with interest. We had invested in the fund that matched our risk 
tolerance.
    The 2010 SEC reforms to MMFs were most welcome and thorough. Our 
research of MMF portfolios (we are always looking for better investment 
opportunities) has shown that since the implementation of the 
enhancements overall, MMFs are safer and the participants are more 
aware of the risks as well as the benefits of investing in these 
instruments. While recognizing the importance of preventing systemic 
and or idiosyncratic events, the stable NAV is critical to State and 
local government participation. As Washington State Treasurer James 
Mcintire pointed out in his letter to the SEC on November 15, 2011, 
``Many local communities and special districts lack the financial 
management and accounting resources to properly equip them to invest in 
floating NAV funds.'' During the Government Finance Officers 
Association's Conference in Chicago last week, the almost unanimous 
consensuses was that if MMFs have floating NAVs most Government 
entities will have to pull their money out. All are struggling with 
budget issues and do not have the resources to enhance personnel or 
systems to accurately account for a floating NAV. This will put further 
strains on their cash management. Furthermore, the banking system is 
not prepared to accept these additional deposits.
Conclusion
    NAST believes that any of the suggested reforms mentioned above may 
further lead to a contraction in the availability of short-term 
financing and adversely affect the investment choices of public funds 
and the continued ability of State Governments, their political 
subdivisions and their respective instrumentalities to obtain financing 
to support the implementation of a wide variety of public initiatives. 
In effect, these regulations will increase costs and will not have the 
intended effect of making MMFs more stable. Of course, additional costs 
will be paid by investors and issuers alike, including the States and 
their taxpayers.
    Many State Treasurers also manage LGIPs, which are pooled 
investment funds operated for the benefit of State or local government 
units. By pooling assets from numerous State and local government 
entities, LGIPs offer economies of scale, liquidity, and 
diversification, thereby reducing costs for them and ultimately for 
taxpayers. While LGIPs are not governed by Commission and Rule 2a-7, 
the investment guidelines for LGIPs typically track the Rule 2a-7. 
Therefore, any changes to MMF rules would also impact the governmental 
entities that invest in LGIPs.
    As State Government officials, State Treasurers have enormous 
respect for and appreciate the responsibilities facing Government 
officials and regulators. No investor or Government official wants to 
again go through an experience as challenging as the financial crisis 
in 2008. However, the rationale for changing MMF regulation should be 
informed by the effectiveness of the amendments to Rule 2a-7 adopted in 
2010 as well as the impact such changes may have on State and local 
governments. We are also concerned about how the changes would impact 
the ability of States to manage LGIPs.
    These changes would simply increase costs to taxpayers by both 
taking away a key investment and cash management tool used by thousands 
of Governments, and possibly curtailing or eliminating the largest 
purchaser of short term municipal debt. Both of these scenarios would 
be the outcome of changing the stable NAV to a floating NAV, and one 
the National Association of State Treasurers would hope leaders in 
Washington, would try to avoid.


[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]



               PREPARED STATEMENT OF PAUL SCHOTT STEVENS
  President and Chief Executive Officer, Investment Company Institute
                             June 21, 2012
Opening Statement
    Good morning, Chairman Johnson, Senator Shelby, and Members of the 
Committee. I very much appreciate the opportunity to appear today to 
offer ICI's perspective on the State of the money market fund industry.
    For almost 5 years, ICI has been deeply engaged in analysis and 
discussion of events in the money market and the role of money market 
funds. We take pride in the fact that our engagement helped produce the 
first comprehensive regulatory reforms for any financial product in the 
wake of the crisis--five months before the Dodd-Frank Act was passed.
    The reforms for money market funds in 2010 benefit investors and 
the economy by raising credit standards and shortening maturities for 
funds' portfolios.
    They remove incentives for investors to redeem rapidly, by 
increasing transparency of fund holdings and authorizing an orderly 
liquidation if a fund risks breaking the dollar.
    And those reforms sharply reduce the spillover effects of money 
market fund redemptions on the broader markets. As of December 2011, 
prime money market funds held $660 billion in assets that would be 
liquid within a week--more than twice the amount that investors 
redeemed from prime funds in the week of September 15, 2008. Today, 
prime funds keep more than 30 percent of their assets in liquidity 
buffers composed primarily of Treasury and Government securities and 
repurchase agreements--precisely the instruments investors were seeking 
in 2008.
    We didn't have to wait long to put these reforms to the test. In 
the summer of 2011, markets were rattled by three significant events: 
the eurozone crisis; the showdown over the U.S. debt ceiling; and the 
historic downgrade by Standard & Poor's of U.S. Government long-term 
debt.
    Money market funds did indeed see large redemptions. From early 
June to early August, investors withdrew 10 percent of their assets 
from prime money market funds--$172 billion in all. During the debt-
ceiling crisis, prime and Government funds together saw an outflow of 
$114 billion in just 4 trading days.
    But this withdrawal from money market funds had no discernable 
effects at all--either on the funds or on the markets. From April 
through December, prime money market funds kept their daily liquidity 
at more than twice the required level, and weekly liquidity stayed one-
third to one-half higher than required.
    Among the prime funds with the greatest exposure to European 
financial institutions, the average mark-to-market price of their 
shares fell by nine-tenths of a basis point. On a $1.00 fund share, 
that's nine one-thousandths of a penny.
    It's clear from this experience that the reforms of 2010 have 
worked--and that money market funds today are a fundamentally different 
product than in 2008.
    Unfortunately, that message hasn't gotten through to the regulatory 
community. They tell us that money market funds are ``susceptible'' to 
runs. They're worried that the Government can't ``bail out'' these 
funds in a future crisis.
    Both of these statements are based in myths.
    Let's look at September 2008. Regulators talk about the 
``contagion'' from Reserve Primary's failure. But Reserve Primary broke 
the dollar in the middle of a raging epidemic of bank failures. In the 
turmoil, banks were refusing to lend to each other, even overnight.
    Two things stand out. First, Reserve Primary's breaking the dollar 
did not trigger the tightening of the commercial paper market--
investors of all types began abandoning that market days before Reserve 
Primary failed. Second, investors did not flee from the money market 
fund structure. Rather, they fled from securities of financial 
institutions and sought the refuge of U.S. Treasury securities--by 
buying shares in money market funds invested in Government securities. 
Assets of taxable funds--prime and Government--declined by only 4 
percent in the week of September 15.
    The Treasury and the Federal Reserve stepped in to restore the 
financial markets. Let me be clear: money market funds received no 
financial support from the Federal Government. The Treasury guarantee 
program never paid a dime in claims--instead, it collected $1.2 billion 
for the taxpayers. It's quite a stretch to call that a ``bailout.'' The 
Federal Reserve's facilities were designed to use money market funds to 
access the markets and pump in needed liquidity. That's Central Banking 
101.
    Our shareholders realize that money market funds are investments--
and they bear the risk of loss. No one in the investment community 
believes that these funds carry a Government guarantee--and no one in 
our industry wants one. Period--full stop.
    In conclusion, let me address the issue of sponsor support for 
funds. Since the 1970s, advisers to money market funds have on occasion 
chosen to address credit or valuation issues in their portfolios and 
support their funds. They did so with private resources--not taxpayer 
dollars. And they did so for business interests--to protect their brand 
or preserve their fund's rating.
    The SEC hasn't released any data to back its claims about sponsor 
support. We can say, however, that we know of only one instance of 
sponsor support since the 2010 reforms, and that in that case the 
security in question was in no danger of defaulting.
    Yet the SEC suggests that every case of sponsor support should be 
seen as a repeat of September 2008. They suggest that without sponsor 
support, money market funds would have triggered runs.
    Decades of experience with these funds suggest just the opposite. 
Before the latest financial crisis, there was only one occasion when a 
money market fund broke a dollar, in 1994. The world yawned.
    Persistently viewing money market funds through the narrow prism of 
2008, the SEC clings to plans to impose structural changes that would 
destroy money market funds, at great cost to investors, State and local 
governments, business, and the economy. That is an outcome that we must 
avoid.
    Thank you, and I'm happy to take your questions.


[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]


    
              PREPARED STATEMENT OF J. CHRISTOPHER DONAHUE
    President and Chief Executive Officer, Federated Investors, Inc.
                             June 21, 2012
Opening Statement
    I would like to briefly respond to the major points made in 
Chairman Schapiro's testimony.
    First, the Chairman is primarily concerned that a credit event will 
cause a money market fund to break a dollar. Rule 2a-7 already makes 
sure these are rare events with minimal impact, but it cannot prevent 
them altogether. We are investment professionals at managing risks, not 
magicians who make risks disappear. The President's Working Group 
acknowledged this when it observed that: ``Attempting to prevent any 
fund from ever breaking the buck would be an impractical goal that 
might lead . . . to draconian and--from a broad economic perspective--
counterproductive measures.''
    Yet this is precisely what a capital requirement attempts to do--
prevent a fund from ever breaking a dollar. The Chairman knows that 
raising capital directly from third parties is impractical, that 
sponsors cannot afford capital and that, at current market rates, funds 
do not have the income to build their own capital cushion. Even at 
normal interest rates, it would take over a decade for funds to build 
even a 1 percent capital cushion on their own. A 1 percent capital 
cushion would not have prevented the Reserve Primary Fund from breaking 
a dollar, so clearly capital will not prevent funds from ever breaking 
a dollar. It may lull shareholders into a false sense of security, 
however, and increase their expectations of a bailout. In short, 
requiring capital would be counterproductive.
    Second, the Chairman asserts that small investors will bear the 
loss from a credit event, because large institutional shareholders will 
redeem before the fund breaks a dollar. This ignores the responsibility 
of the fund's directors in protecting the interest of all shareholders. 
In fact, if you listened only to the Chairman's speeches and testimony 
on money market funds, you would never know that funds have directors, 
a majority of whom are independent of the fund's manager, or that Rule 
2a-7 has always required them to prevent material dilution or other 
unfair results to shareholders.
    The contrast between the actions of the directors of the Reserve 
Primary Fund and the directors of the Putnam Prime Money Market Fund 
during the financial crisis is instructive. The Reserve Fund directors 
allowed shareholders to continue redeeming for a dollar for more than a 
day after the Lehman bankruptcy, even though Reserve did not provide 
any concrete support to the fund. They may have done this because, at 
the time, directors could not suspend redemptions without first 
obtaining an order from the Commission. Notwithstanding this, when 
faced with redemption requests in excess of their fund's liquidity, the 
Putnam Fund directors suspended redemptions until they could arrange a 
merger with a Federated advised money market fund which had access to 
the Federal Reserve's liquidity program for asset-backed securities. By 
making their shareholders' interest paramount to all other 
considerations, the Putnam Fund directors protected their shareholders, 
large and small.
    Despite her professed concern for small investors, the Chairman has 
never mentioned any reforms that would make it easier for directors to 
protect them or that would help directors prepare for an event that 
might threaten their fund's $1 NAV.
    Third, the Chairman persists in assuming that a money market fund 
breaking a dollar will cause a run by its shareholders, which will lead 
to a fire sale of the portfolio, which will result in a downward spiral 
of asset prices and a credit crunch. Her assumptions are based on the 
behavior of prime fund shareholders during the greatest financial 
crisis since the Great Depression; a crisis that was fully underway 
before the Reserve Fund broke a dollar. She ignores the fact that none 
of these things occurred when the Community Bankers fund broke a dollar 
in 1994, when the market was not undergoing a liquidity crisis.
    The Chairman did announce yesterday, with much fanfare, that 
sponsors have had to step in 300 times to prevent their funds from 
breaking a dollar. While I share Senator Toomey's skepticism as to how 
her staff arrived at this figure, I also wonder what we are supposed to 
conclude from this number. She admits that sponsor support is not 
necessarily a bad thing. She cannot be suggesting that funds are 
regularly on the verge of breaking a dollar--her written statement says 
that these 300 ``occasions'' relate to about a dozen credit events over 
a span of three decades. I think that the ability of sponsors to handle 
nearly all of these events without Government intervention demonstrates 
the inherent strength and resilience of money market funds. I bet the 
FDIC would be envious of this record.
    Tellingly, the Chairman ignores how the reforms adopted in 2010 
addressed all of her assumed problems.

    Funds that break a dollar can now suspend redemptions and 
        liquidate without a Commission order, so funds can stop a run 
        by their shareholders.

    Investors can see all of their fund's holdings, so they 
        would know that other funds are not at risk of breaking a 
        dollar.

    Funds currently have three times the liquidity needed to 
        handle the level of redemptions experienced during the 
        financial crisis, so funds would not need to conduct fire sales 
        and would not cause asset prices to spiral downward.

After the 2010 reforms, there is no reason to suppose that a fund 
breaking a dollar will snowball into some sort of credit crunch.
    Fourth, the Chairman's dogmatic belief in the systemic risks of 
money market funds will necessarily taint any cost/benefit analysis of 
her proposed reforms. If she begins by assuming that a fund breaking a 
dollar will cascade into a full scale financial crisis of the magnitude 
experienced in 2008, then the case for reform is a foregone conclusion. 
In other words, she would make perfection the enemy of the good. If it 
adopts reforms on this basis, the Commission will sacrifice real, 
quantifiable benefits to millions of shareholders and borrowers for 
speculative and unsubstantiated reductions in supposed systemic risks. 
This approach to risk/reward analysis would be like requiring 
passengers on a cruise ship to spend the trip in the life boats: you'd 
be safer in theory, but it would defeat the purpose. Ironically, if (as 
every survey indicates) her proposed reforms will drive shareholders 
out of money market funds and into the largest banks, then they will 
increase systemic risk and make credit markets more fragile.
    Finally, the Chairman calls for an honest, public debate of her 
proposed reforms. Federated already tried the case for a stable NAV in 
an evidentiary heading before an administrative judge in the 1970s, 
which the Commission settled by issuing the original exemptive orders 
permitting use of amortized cost valuation. More recently, the 
Commission requested comment on a floating NAV in both the reforms 
proposed in 2009 and in connection with the President's Working Group 
report. No one, apart from members of the Federal Reserve and 
academics, supported this proposal. Essentially, the Chairman is 
insisting that the debate on floating the NAV continue until she gets 
the answer she wants.
    Regarding her alternative reforms, I have explained why it is not 
feasible to impose a meaningful capital requirement. Although the 
Chairman did not say much about redemption restrictions, she knows that 
there are insurmountable legal and operational obstacles to such 
restrictions. She has no reason to believe that investors will continue 
to use funds subject to these restrictions. Therefore, all of the 
Chairman's proposals would have the same result--the effective 
destruction of money market funds.
    I look forward to answering your questions.

Prepared Statement
    Chairman Johnson, Ranking Member Shelby, Members of the Committee, 
I want to thank you for providing me the opportunity to appear at 
today's hearing. I am the President and CEO of Federated Investors, 
Inc. (Federated), the third largest manager of money market funds 
(MMFs) in the United States. Our MMFs currently have assets of 
approximately $240 billion, with millions of individual and thousands 
of institution shareholders for whom we provide investment management, 
including corporations, Government entities, insurance companies, 
foundations and endowments, banks, and broker-dealers. Federated has 
1,450 employees.
    Federated has provided extensive data and commentary to the 
Securities and Exchange Commission (SEC), in response to its request 
for comments on the Report of the President's Working Group on 
Financial Markets regarding possible changes to MMFs (the ``PWG 
Report'') \1\ and to the Financial Stability Oversight Council (FSOC) 
and banking regulators in connection with rule making proposals to 
implement Titles I and II of the Dodd-Frank Wall Street Reform and 
Consumer Protection Act (the ``Dodd-Frank Act''). A list of links to 
Federated's comment letters is included at the end of my statement.
---------------------------------------------------------------------------
     \1\ The PWG Report was published for comment in Release No. IC-
29497, ``President's Working Group Report on Money Market Funds'' (Nov. 
3, 2010), available at http://www.sec.gov/rules/other/2010/ic-
29497.pdf.
---------------------------------------------------------------------------
    We are concerned that, based upon recent speeches by the SEC 
Chairman and a number of members of the Federal Reserve Board, key 
regulators have largely disregarded the comments received in response 
to the PWG Report--not only Federated's comments, but also others who 
pointed out errors underlying, obstacles to and unintended consequences 
of possible reforms. More disturbingly, although as of this date 
neither the SEC nor FSOC have proposed rules or other action 
specifically targeting MMFs, key members of both agencies have 
continued to pursue reform proposals heedless of the PWG Report's 
important warning that ``[a]ttempting to prevent any fund from ever 
breaking the buck would be an impractical goal that might lead . . . to 
draconian and--from a broad economic perspective--counterproductive 
measures . . . '' \2\ Their attempt to eliminate risk from MMFs has 
resulted in draconian proposals that would eliminate MMFs, if not 
altogether, then as a meaningful component of the U.S. cash markets.
---------------------------------------------------------------------------
     \2\ PWG Report at 13.
---------------------------------------------------------------------------
    Let us remember that money market funds did not cause the recent 
financial crisis. \3\ They were simply not immune to the largest 
financial crisis since the Great Depression. Yet instead of targeting 
the causes of the crisis, the SEC Chairman and certain members of the 
FSOC have threatened ill-conceived reforms whose demonstrable costs far 
outweigh any plausible benefits. Indeed, even the existence of a 
benefit from the proposals being discussed is debatable when a full 
accounting of the impact on the banking system and the expansion of the 
Federal safety net are taken into account. The flawed process leading 
to this outcome--where bank regulators now dictate the content of 
securities law without meaningful dialog with those affected or serious 
study of unintended consequences--does not embody the best traditions 
of Government. It is therefore incumbent upon all of us, regulators, 
industry and Congress, to bring perspective and rationality to the 
debate. It is our obligation to weigh the enormous benefits of MMFs 
against a realistic assessment of the speculative benefits, and 
evidence of significant adverse economic consequences, that the various 
``reform'' proposals would bring. We strongly endorse Congressional 
efforts to clarify the SEC's statutory obligation to perform cost/
benefit analysis and to commission a thorough evaluation of the need 
for additional reform to money market funds. Such a study should not 
only include an evaluation of the impact of the 2010 reforms to MMF 
regulations, but also should factor in the reforms adopted in the Dodd-
Frank Act. Americans deserve a regulatory process that can hear their 
voice: they would prefer to keep the massive efficiency gains with the 
current system and accept the risk of a very high quality, tightly 
regulated investment product, rather than turn back the clock and 
return to a world even more dominated by the largest banks.
---------------------------------------------------------------------------
     \3\ ``Dissecting the Financial Collapse of 2007-2008: A Two-Year 
Flight to Quality'', May 2012, available at http://www.sec.gov/
comments/4-619/4619-188.pdf.
---------------------------------------------------------------------------
Setting the Record Straight on Money Market Funds
    Before addressing these threatened reforms, I would like to dispel 
some myths regarding MMFs that purport to justify the need for further 
reforms.

Myth: The $1 share price of MMFs is a ``fiction'' or ``gimmick.''

Fact: The stable $1 price is real--MMFs have redeemed their shares for 
at a stable $1 price for over 40 years, with only two exceptions.

    Every day, for over 38 years, Federated's MMFs have redeemed shares 
at a stable $1 value. This is true of every other MMF currently in 
existence. During the past 40-plus years, only two MMFs have redeemed 
shares for less than a $1, known as ``breaking a dollar.''
    This record of stability is the result of the high quality and 
short-duration of MMF portfolios, not accounting wizardry. Regulations 
require MMF portfolios to consist of a diversified cross-section of the 
highest quality debt instruments available in the market. The market 
values of these instruments rarely deviate significantly from their 
amortized cost. Federated regularly monitors the estimated market value 
of its MMFs (known as their ``shadow prices''), which typically do not 
deviate by even a tenth of a cent from $1 (i.e., 10 basis points). An 
Investment Company Institute (ICI) sampling of the shadow prices of 
other MMFs shows that this is common throughout the industry. \4\
---------------------------------------------------------------------------
     \4\ ``Pricing of U.S. Money Market Funds at 4'', ICI Research 
Report (Jan. 2011), available at http://www.ici.org/pdf/
ppr_11_mmf_pricing.pdf.
---------------------------------------------------------------------------
    Such small shadow price deviations do not affect a MMF's ability to 
operate at a stable value because portfolio instruments quickly return 
to their amortized cost. MMFs typically maintain an average maturity of 
between 30 and 50 days. This makes it easy for MMFs to wait for 
investments to mature, rather than selling them at a gain or loss.
    MMFs also avoid gains and losses by maintaining more than enough 
liquidity to meet anticipated shareholder redemptions. This ``best 
practice'' was codified in the regulatory reforms adopted in 2010. The 
MMFs' record for managing liquidity is exemplary--no fund has ever 
broken a dollar because a fund failed to maintain sufficient liquidity 
to meet redemptions. The capacity of some MMFs to maintain daily 
liquidity was tested again in the summer of 2011, and every fund 
answered the challenge without any disruption to the market.
    On a related point, critics sometimes assert that the $1 share 
price misleads investors into believing that MMFs are like banks. These 
critics overlook the fact that most of the money held in MMFs comes 
from sophisticated institutional investors, who surely appreciate the 
differences between MMFs and banks. Recent surveys show that most 
retail investors also appreciate that their MMF can break a dollar and 
that no one has promised to protect them from any losses. \5\ These 
critics further ignore the bold face disclaimer on the front of every 
Federated MMF prospectus and advertisement: ``Not FDIC Insured--May 
Lose Value--No Bank Guarantee.'' Thus, MMFs fully disclose the risk 
that they may break a dollar and the overwhelming majority of MMF 
shareholders understand and accept this risk.
---------------------------------------------------------------------------
     \5\ ``The Investor's Perspective: What Individual Investors Know 
About the Risks of Money Market Mutual Funds'', FMR LLC (Apr. 2012), 
available at http://www.sec.gov/comments/4-619/4619-170.pdf.

Myth: MMFs have only been able to maintain a $1 share price due to the 
---------------------------------------------------------------------------
support provided by their managers.

Fact: Over 90 percent of MMFs have maintained a $1 share price without 
any support from their managers.

    At the beginning of 2007, there were 728 MMFs. The Federal Reserve 
has recently asserted that, from 2007 to 2010, approximately 50 MMFs 
received support from their manager. \6\ This means that over 90 
percent of MMFs maintained a $1 share price throughout the recent 
financial crisis without any support from their managers. All of 
Federated's MMFs maintained a $1 share price without any support from 
Federated during the period. Historically, managers have provided 
support to their funds in part because they typically do not incur any 
losses as a result of the support. This explains why managers commonly 
find it in their interest to protect their MMFs' shareholders at no 
material cost to themselves. Although no manager promises to provide 
support for its funds, mutually beneficial support arrangements should 
be appreciated as an indication of the resilience of MMFs rather than 
as a weakness.
---------------------------------------------------------------------------
     \6\ Presentation by Federal Reserve Bank of Boston President 
Rosengren (Apr. 11, 2012), available at http://www.frbatlanta.org/
documents/news/conferences/12fmc/12fmc_rosengren_pres.pdf.

---------------------------------------------------------------------------
Myth: MMFs are susceptible to runs.

Fact: In over 40 years, there has been only one run on prime MMFs and 
it was a consequence of a general flight to safety at the height of the 
financial crisis.

    As I noted, there have been two instances of a MMF breaking a 
dollar. The first, in 1994, did not produce a run on MMFs. In fact, it 
went largely unnoticed. The second, the Reserve Fund, coincided with 
the redemption of approximately 15 percent of the assets held by prime 
MMFs during the week of September 15, 2008.
    So far as I know, the SEC has not attempted to study why breaking a 
dollar in 1994 had no impact on other funds, while prime MMFs 
experienced substantial redemptions at the time the Reserve Fund broke 
a dollar. The SEC appears to assume that, because the run on MMFs 
coincided with the Reserve Fund breaking a dollar, the Reserve Fund 
caused the run. A comparison of the market conditions in 1994 and 2008 
refutes this assumption.
    In 1994, the Community Bankers MMF broke a dollar because it held 
derivative securities that the SEC found ``were too risky and volatile 
for a money market fund.'' \7\ The credit market was operating 
normally, so there were no concerns about the availability of 
liquidity. The market therefore viewed Community Bankers as an isolated 
incident, with no implications for other MMFs or for the market in 
general. Shareholders did not run from other MMFs because they had no 
reason to suspect that another MMF would break a dollar.
---------------------------------------------------------------------------
     \7\ In the Matter of Craig S. Vanucci and Brian K. Andrew, 
Investment Company Act Release No. 23638 (Jan. 11, 1999), available at 
http://www.sec.gov/litigation/admin/33-7625.txt.
---------------------------------------------------------------------------
    In contrast, 2008 was marked by a complete loss of confidence in 
the financial system. The run on MMFs coincided with the rescue of AIG, 
the arranged merger of Merrill Lynch with Bank of America and many 
other financial shocks. Many investors were uncertain as to whether 
other financial institutions would fail and whether they would receive 
Government support. Rather than risk a default, these investors sought 
to shift their cash to Government securities, draining liquidity from 
the credit market. The credit market was completely frozen before the 
Reserve Fund tried to liquidate its portfolio.
    Other MMFs were not immune to this market turmoil. Their 
shareholders also fled to Government securities, as evidenced by the 
fact that nearly two-thirds of the assets redeemed from prime MMFs were 
added to Government MMFs. This also shows that redemptions were 
motivated by concerns regarding the credit market generally and not 
MMFs themselves. This suggests that the shareholders would have 
redeemed regardless of whether the Reserve Fund broke a dollar, in 
order to eliminate credit risk by shifting their cash to Government 
securities.
    Thus, the record over the past 40 years includes one fund that 
broke a dollar without causing a run, and one run that coincided with a 
MMF fund breaking a dollar but was largely caused by a flight to safety 
in response to an unprecedented financial crisis. That certainly does 
not qualify MMFs as ``susceptible'' to runs. There is no reason to 
project that an event in the future that causes one or more MMFs to 
break a dollar would prompt shareholders to redeem from other MMFs not 
affected or threatened by the event. Indeed, in light of the 
significant enhancements in transparency and liquidity of MMFs 
following the 2010 reforms, MMF investors should be even less likely to 
run.

Myth: Taxpayers rescued MMFs in 2008.

Fact: We did not ask for or need the Treasury's Temporary Guarantee 
Program (the ``Treasury Program'') and no claims were made under the 
program.

    MMFs required liquid markets, not tax dollars, to weather the 
financial crisis in 2008. Their portfolios were sound, but the global 
liquidity crisis impacted MMFs just as it did virtually all other asset 
classes.
    Due the lack of market liquidity, we requested liquidity, rather 
than Federal insurance, for our MMFs in response to the financial 
crisis. During our discussions, the Treasury told us that the Treasury 
Program was going to be announced; we never asked for it. We did not 
think that the Treasury Program addressed the real problem--the need to 
reassure shareholders that MMFs had enough liquidity to continue to 
redeem their shares for $1.
    In my view, the Federal Reserve's Asset-Backed Commercial Paper 
Money Market Mutual Fund Liquidity Facility (AMLF), \8\ rather than the 
Treasury Program, restored confidence in MMFs. AMLF provided funding to 
banks and other institutions to buy asset-backed commercial paper from 
MMFs. AMLF ultimately funded sales of approximately $220 billion, a 
small fraction of the massive liquidity the Federal Reserve pumped into 
virtually every corner of the financial markets during the crisis.
---------------------------------------------------------------------------
     \8\ Information on AMLF can be found at http://
www.federalreserve.gov/newsevents/reform_amlf.htm. Another liquidity 
facility, the Money Market Investor Funding Facility was established 
but never utilized.
---------------------------------------------------------------------------
    AMLF was announced on the same day as the Treasury Program--
September 19, 2008. By the second week of October, prime MMF assets had 
stabilized. Although some would attribute this to the combination of 
AMLF and the Treasury Program, it is noteworthy that prime fund assets 
grew continuously throughout the rest of 2008, even though the Treasury 
Program only covered balances held on September 19th, so these 
additional assets were not guaranteed. Moreover, the Treasury Program 
was limited to $50 billion, which was just over 1 percent of the 
September 19th MMF assets. Thus, within four weeks of the onset of the 
financial crisis, investors were confident enough to invest in prime 
MMFs without reliance on a Federal guarantee.
    Regardless of the reasons, it cannot be disputed that confidence in 
prime MMFs was fully restored without any Federal expenditures. In 
fact, the Treasury kept all $1.2 billion of premiums paid under the 
Treasury Program without paying any claims. All of the paper sold under 
AMLF was repaid in full, with interest, when due.
    The recovery of prime MMFs with a relatively minor liquidity 
program is a testament to the inherent resiliency of MMFs. If banks and 
other financial institutions had responded as well to their support 
measures, which included trillions in additional Federal deposit 
insurance, multiple liquidity programs and the investment of hundreds 
of billions under TARP, the financial crisis would have been resolved 
before the end of 2008. MMFs were the last institutions to require a 
liquidity program and the first to recover--a mark of resiliency and 
not of ``fragility.''
The 2010 Reforms Addressed the Need for Liquidity During a Financial 
        Crisis
    MMFs were not only the first to recover from the financial crisis; 
they also were the first to adopt reforms to prevent a recurrence of 
problems encountered during the crisis. In March 2009, the ICI provided 
the SEC with proposed regulatory reforms. Using the ICI's report as a 
starting point, the SEC proposed reforms in June of 2009 and adopted 
final rules in February 2010. Most of the reforms were implemented by 
May 2010 and the balance by the end of that year. No other industry 
responded as promptly or adopted such far-reaching reforms as MMFs.
    Four of the reforms targeted liquidity. First, the SEC adopted a 
new rule, 22e-3, permitting a MMF's board of directors to suspend 
redemptions while liquidating a fund. This gives directors two options 
if a MMF breaks a dollar. If there is adequate market liquidity, the 
fund can operate with a fluctuating NAV and sell its portfolio to pay 
for redemptions. If markets are frozen or it would otherwise serve the 
shareholders' interest, the directors can suspend redemptions and 
distribute payments from the portfolio as it matures. As I mentioned, 
MMFs historically maintain average maturities of 30 to 50 days, so 
shareholders would receive most of their money back within this period. 
The maximum permitted maturity is 397 days, so the liquidation would 
not take much longer than a year to complete.
    Rule 22e-3 gives directors the power to prevent a run from a MMF 
that has broken or threatens to break a dollar. It also prevents a fire 
sale of the portfolio into an illiquid market. The result is that every 
MMF, not just the largest, already has the type of orderly resolution 
plan contemplated by Title II of the Dodd-Frank Act, except that the 
plan does not require a Federal receiver or Federal insurance.
    The second reform was to increase transparency. Every MMF must post 
its entire portfolio on its Web site as of the end of each month. This 
allows the public and regulators to identify which MMFs are affected by 
a credit or other adverse event Although affected MMFs may need to 
address the event, shareholders in unaffected funds will not face the 
same uncertainty as investors in banks and other less transparent 
institutions. They should not have any reason to redeem from MMFs that 
they know to be sound and unimpaired by the event.
    The third reform codified an industry practice of knowing your 
customers and monitoring their share activity. This requires that a MMF 
manager monitor and prepare for the risk of large shareholder 
redemptions, taking into account current market conditions. This is 
designed to assure that MMFs remain prepared to meet their 
shareholders' liquidity needs.
    The final reform deals with the possibility that some shareholders 
may nevertheless redeem from MMFs on the occurrence of certain market 
events, regardless of their actual risks. The reform established 
liquidity floors: minimum amounts of liquidity that each MMF must be 
able to generate on a daily and weekly basis without selling anything 
other than Treasury and other Government securities. The floors are 10 
percent for daily liquidity and 30 percent for weekly liquidity. 
Remember that 15 percent of prime fund assets were redeemed during the 
week of September 15, 2008, so the weekly liquidity floor is twice the 
level of redemptions experienced during that period. In these still 
uncertain times, prime MMFs are maintaining an average weekly liquidity 
of 43 percent, nearly three times the level of the 2008 redemptions. 
\9\
---------------------------------------------------------------------------
     \9\ ICI summary of data from Form N-MFPs as of April 30, 2012.
---------------------------------------------------------------------------
    These reforms were tested during the summer of 2011. In response to 
concerns about European banks and whether Congress would raise the U.S. 
debt ceiling, shareholders redeemed over 10 percent of prime MMF assets 
during the period from June 8 through August 3, 2011. \10\ As you would 
expect, redemptions were higher in some prime MMFs than in others. None 
of the MMFs had trouble meeting these redemption requests and there was 
no impact on the overall market. Throughout the period, average weekly 
liquidity in prime MMFs remained at 40 percent or more, so the funds 
covered these redemptions without tapping into their liquidity cushion. 
The new reforms clearly passed this real-life stress test.
---------------------------------------------------------------------------
     \10\ ``ICI Summary: Money Market Funds Asset Data'', available at 
http://www.ici.org/info/mm_summary_data_2012.xls.
---------------------------------------------------------------------------
    Certain members of FSOC and the Chairman of the SEC contend that 
more must be done to prevent a recurrence of the redemptions 
experienced in September 2008. Apart from ignoring the fact that prime 
MMFs are already prepared to handle significantly larger redemptions, 
their contention also ignores how the redemptions resulted from a 
general financial panic. No reform of MMFs can prevent shareholders 
from seeking a safe haven during such a complete loss of investor 
confidence. Efforts to eliminate all risks from MMFs will not prevent a 
future crisis; they will only eliminate MMFs.
Reforms Currently Under Consideration Are Fundamentally at Odds With 
        the Nature of Money Market Funds and the Needs of Their 
        Shareholders
    Investors use MMFs to obtain stability and daily liquidity with a 
market rate of return. Each of the reforms that the SEC Chairman has 
recommended: a floating NAV, redemption restrictions and capital, would 
eliminate one of these essential elements. The consequences of these 
reforms would therefore be, from an investor's perspective, the 
elimination of MMFs as a viable alternative for cash investment. This 
is confirmed by surveys and other data, which suggest that the 
threatened reforms would drive upwards of three-quarters of their 
assets from MMFs.
(a) MMF NAVs Should Only Float When Necessary To Protect Shareholders
    MMFs already have floating NAVs, as demonstrated by the fact that 
funds have broken a dollar. The question is how often the NAV should 
float. Under current regulations, directors must float the NAV when 
necessary to protect shareholders from excessive dilution or other 
unfair results. Dilution is presumed to be excessive when the shadow 
price deviates from $1 by more than half a cent, although directors 
retain some latitude for judgment even in this circumstance.
    The threatened reform would require the NAV to float regardless of 
the shareholders' interest. Studies of historical shadow prices show 
that share prices would fluctuate infrequently, with periods of several 
years between price fluctuations. Moreover, the price changes would 
typically not amount to more than one or occasionally two-tenths of a 
percent and would not last for longer than several weeks. The potential 
fluctuations would require shareholders to monitor, calculate and 
record infinitesimal and ephemeral gains and losses on cash investments 
for accounting and tax purposes. From a shareholder's perspective, 
dealing with these potential price fluctuations would result in 
enormous costs.
    Surveys show that investors would rather move their money elsewhere 
rather than deal with such pointless fluctuations. \11\ Many 
fiduciaries will not have a choice, as statutes or trust instruments 
may require investment of cash in stable value investments. Therefore, 
eliminating the stable value that, under normal circumstances, 
shareholders want and MMFs deliver will eliminate MMFs as a viable 
alternative for most cash investors.
---------------------------------------------------------------------------
     \11\ ``The Investor's Perspective: What Individual Investors Know 
About the Risks of Money Market Mutual Funds'', supra note 5, and 
``Money Market Fund Regulations: The Voice of the Treasurer'', Apr. 
2012, available at http://www.ici.org/pdf/
rpt_12_tsi_voice_treasurer.pdf.
---------------------------------------------------------------------------
(b) Redemption Restrictions Could Be Worse Than Floating NAVs
    Shareholders object to redemption restrictions even more strongly 
than they do to a floating NAV. This is understandable: although a 
floating NAV would cause share prices to fluctuate needlessly, the 
fluctuations would be infrequent and temporary. Redemption 
restrictions, on the other hand, would continually disrupt a 
shareholder's access to his or her cash in order to address an event 
(the fund breaking a dollar) that might occur once in 20 years, if it 
ever occurs at all. Their reaction is similar to passengers on a cruise 
who have been asked to confine their activities to the lifeboats just 
in case the ship hits an iceberg.
    In addition to shareholders' rejection of redemption restrictions, 
there are no practical means of implementing them. Although the SEC has 
not provided any details of the redemption restrictions under 
consideration, as a general matter they must involve: (1) setting aside 
a certain percentage of shares or proceeds from the redemption of 
shares for a period of time and (2) charging any losses incurred by the 
fund during the period against the shares or proceeds set aside. Fund 
organizational documents and share trading systems were not designed to 
do these things. Therefore, implementing redemption restrictions would 
entail completely rewriting every fund's organization documents and 
getting shareholders to approve the changes, and reprogramming every 
trading system for fund shares. The transition costs would be 
staggering, as would the ongoing operational cost of tracking and 
restricting shares or proceeds. Many intermediaries would probably stop 
offering MMFs rather than bear these costs.
(c) Reguiring Excess Capital Would Prevent Money Market Funds From 
        Offering a Market Rate of Return and Introduce Moral Hazards
    Even the SEC Chairman and members of the FSOC seem to have realized 
that forcing MMFs to raise subordinated capital from third parties or 
their managers would make the fund unduly complicated and impractical. 
I will therefore assume that the only capital proposal still under 
consideration would be for MMFs to build up capital over time through 
retaining a portion of their earnings. From a shareholder's 
perspective, this form of capital requirement would impose a certain 
loss--in the form of reduced returns--in order to reduce the risk of a 
speculative loss--the possibility that the fund might break a dollar.
    It also would take an exceedingly long time to build up a 
significant capital buffer. With interest rates currently near zero, 
MMFs do not have any income to retain for a capital buffer. Even in 
normal market conditions, the yield on a prime MMF averages only 18 
basis points more than the yield on a Government agency MMF. Assuming 
for purposes of analysis that the difference is constant, which it is 
not, and that shareholders would continue to use prime MMFs if this 
spread was cut in half, which they may not, it would take over 11 years 
for a prime fund to build a 1 percent capital buffer through retained 
earnings.
    This analysis does not include the taxes imposed on the fund's 
retained income. After factoring in State taxes, close to half of any 
earnings reduction will go to the Government rather than building a 
capital buffer for the shareholders. Federal corporate income taxes 
alone, at current rates, would increase the time required to build a 1 
percent capital buffer to more than 17 years.
    Capital buffers also could create a moral hazard by leading MMF 
shareholders to believe that they will not bear the risk of portfolio 
losses. This can only increase expectations that a MMF should be bailed 
out if its losses exceed the capital buffer, as Federal regulators 
would have represented to the public that their capital requirements 
were sufficient to make MMFs safe. The financial system will be better 
off if the hint of protection from a capital buffer does not dilute 
current warnings that MMFs are not guaranteed and may lose money.
    Once we understand that MMFs are investments, we should realize 
that MMFs are already funded entirely by shareholder capital. 
Shareholders receive higher yields to compensate them for the risk of 
their MMF breaking a dollar, which has proven to be a highly profitable 
arrangement for MMF shareholders.
Destruction of Money Market Funds Will Injure the Economy and Increase 
        Systemic Risks
    As I noted, the best available estimates suggest that requiring a 
floating NAV or redemption restrictions will drive upwards of three-
quarters of the assets out of MMFs. At current asset levels, this would 
comprise more than $2 trillion. It is harder to estimate the impact of 
capital requirements, insofar as we do not know the elasticity of 
demand for prime MMFs relative to their spread over Government MMFs. 
Reduced returns will surely translate into reduced assets, however.
    Where would all this money go? Very large institutional investors, 
those with over $100 million in investments who could qualify for the 
Rule 144A safe harbor, might invest directly in the same instruments as 
MMFs. They would have to hire managers for these investments, who would 
be unlikely to have as many resources or as much experience as those 
who currently manage MMFs. The portfolios would not be as well 
diversified as MMFs. A better alternative for these institutions might 
be to invest in a private MMF, completely unregulated by the SEC. Thus, 
one consequence of the threatened reforms would be to reduce the SEC's 
oversight and regulation of participants in the money markets.
    Other institutional investors, and nearly all retail investors, 
would have to move their cash to banks. This would increase systemic 
risks in several respects. First, bank holding companies already 
designated as systemic risks under the Dodd-Frank Act control over half 
of MMF assets. \12\ This suggests that most of the money driven out of 
MMFs will end up in banks that are already too big from a systemic risk 
perspective.
---------------------------------------------------------------------------
     \12\ Crane Data.
---------------------------------------------------------------------------
    Second, much of the retail and some of the institutional money will 
end up in insured accounts, increasing the size of the Federal safety 
net. Banks will also need to raise additional capital for these 
deposits, at a time when they are already straining to comply with the 
new Basil III requirements.
    Third, to limit the need for additional capital, banks are unlikely 
to use the new funds to make commercial loans. Unlike prime MMFs, which 
have to put every dollar to work, banks have the option of leaving 
funds in their Federal Reserve accounts. Banks may also find it easier 
to invest in Treasury and Government agency securities. To the extent 
that banks choose to make commercial loans, the absence of competition 
from MMFs will allow them to charge higher interest rates. Hence, the 
reduction in prime MMF assets will produce a corresponding reduction in 
credit to the private sector and an increase in the cost of such 
credit. If we consider that prime MMFs hold over 40 percent of the 
outstanding commercial paper, we can appreciate the potential impact of 
this on the economy.
    The credit impact on municipalities will be even worse. Most 
municipalities rely on loans from tax-exempt MMFs to bridge the period 
between expenditures and periodic tax collections. Before MMFs, banks 
provided this financing, charging municipalities the prime rate for 
their working capital. Assuming banks will return to this role, the 
additional interest charges will place a considerable drag on already 
over-burdened municipal budgets.
    The reforms will destroy MMFs in a more fundamental sense as well. 
As I observed, investors look to MMFs for stability and daily liquidity 
with a market rate of return. A floating NAV would prevent MMFs from 
offering stability, redemption restrictions would prevent them from 
offering daily liquidity, and capital requirements would prevent them 
from offering a market rate of return. Therefore, all of the reforms 
are designed to eradicate MMFs as we now know them, rather than to 
``shore up'' the funds as asserted by the SEC's Chairman.
The SEC Should Conduct a Thorough Study of Money Market Funds, Their 
        Shareholders and the Effects of the 2010 Reforms and the Dodd-
        Frank Act Before Proposing Any Further Reforms
    Previous reforms to MMF regulations involved careful examinations 
by the SEC staff of the performance and operations of MMFs, including 
on-site visits and face-to-face discussions with fund managers. In the 
case of the 2010 reforms, the SEC staff had the benefit of a report and 
recommendations from the ICI's Money Market Fund Working Group. The 
Working Group was composed primarily of portfolio managers who had 
hands-on experience in guiding their MMFs through the 2008 financial 
crisis. This put them in the best position to know what tools and 
changes might serve to avoid or manage another crisis. The SEC gave 
serious consideration to the reforms proposed by the ICI Working Group. 
Although the reforms adopted by the SEC in 2010 went further than 
Federated thought was warranted, the reforms were largely consistent 
with the information provided in the Working Group's report.
    Such due diligence and interaction has been lacking in this 
``second phase'' of the reform process. So far the process has 
consisted of a series of trial balloons floated by the regulators and 
shot down by the industry, representatives of MMF shareholders and 
organizations concerned with the efficiency of short-term credit 
markets. The SEC staff has not made any efforts to look beyond 
industry-level data and examine what happened to individual funds and 
shareholders during September 2008, or to establish what changes might 
be realistic from a performance or operational perspective.
    The 2010 reforms require MMFs to file a monthly report with the SEC 
containing volumes of information regarding their portfolios. The SEC 
staff has yet to use this information to provide any public assessment 
of the impact of the 2010 reforms on the risks and character of MMFs. 
In addition, the SEC staff has not attempted to analyze whether the 
``know your customer'' requirements of the 2010 reforms have affected 
fund cash flows.
    As a first critical step in their cost/benefit analysis of possible 
reforms, the SEC staff must identify the benefits of MMFs to investors, 
capital formation and market efficiency, and quantify these benefits to 
the fullest possible extent. They must quantify how the proposed 
reforms would jeopardize these benefits. As numerous commenters have 
documented significant adverse consequences, the SEC must thoroughly 
evaluate the associated cost and risk to the capital markets and 
economy, including the substantial risk of the loss or increased cost 
of credit to the many borrowers who rely on MMFs for short term 
funding.
    The SEC staff also must demonstrate and measure any purported 
reduction in systemic risk of a proposed reform. The SEC may not, as 
Commissioner Gallagher aptly put it, ``simply hand-wave and speak 
vaguely of addressing `systemic risk' or some other kind of protean 
problem.'' \13\ I hope that the Committee agrees that any further 
reforms of MMF regulations should comply with the same rigorous 
standards for cost/benefit analysis that the SEC has represented it 
will apply to regulations mandated by the Dodd-Frank Act.
---------------------------------------------------------------------------
     \13\ ``SEC Reform After Dodd-Frank and the Financial Crisis'', 
speech by Commissioner Daniel M. Gallagher before the U.S. Chamber of 
Commerce (Dec. 14, 2011), available at http://www.sec.gov/news/speech/
2011/spch121411dmg.htm.
---------------------------------------------------------------------------
    The ICI, Federated, and other MMF managers, and other organizations 
have attempted to fill this information gap by sponsoring surveys and 
preparing studies of the financial and operational impact of various 
proposals. With the advent of FSOC, the SEC staff no longer appears to 
give this information the same consideration that they gave to the ICI 
Working Group report. Certainly the SEC Chairman continues to make 
public statements that either are contradicted by these studies or fail 
to acknowledge important issues raised by them.
    Although I confess to being skeptical of the need for further 
reforms, Federated is willing to consider and assist the SEC, the ICI 
and the industry in assessing reform proposals that would enhance the 
resilience of MMFs. I am asking this Committee to encourage the SEC to 
do the research necessary to determine what changes, if any, are truly 
needed, and to express its commitment to the continued vitality and 
growth of this important investment product.
    I look forward to answering your questions.


[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]


                  PREPARED STATEMENT OF BRADLEY S. FOX
              Vice President and Treasurer, Safeway, Inc.
                             June 21, 2012
    The U.S. Chamber of Commerce is the world's largest business 
federation, representing the interests of more than 3 million 
businesses of all sizes, sectors, and regions, as well as State and 
local chambers and industry associations.
    More than 96 percent of the Chamber's members are small businesses 
with 100 or fewer employees, 70 percent of which have 10 or fewer 
employees. Yet, virtually all of the Nation's largest companies are 
also active members. We are particularly cognizant of the problems of 
smaller businesses, as well as issues facing the business community at 
large.
    Besides representing a cross-section of the American business 
community in terms of number of employees, the Chamber represents a 
wide management spectrum by type of business and location. Each major 
classification of American business--manufacturing, retailing, 
services, construction, wholesaling, and finance--is represented. Also, 
the Chamber has substantial membership in all 50 States.
    The Chamber's international reach is substantial as well. It 
believes that global interdependence provides an opportunity, not a 
threat. In addition to the U.S. Chamber of Commerce's 115 American 
Chambers of Commerce abroad, an increasing number of members are 
engaged in the export and import of both goods and services and have 
ongoing investment activities. The Chamber favors strengthened 
international competitiveness and opposes artificial U.S. and foreign 
barriers to international business.
    Positions on national issues are developed by a cross-section of 
Chamber members serving on committees, subcommittees, and task forces. 
More than 1,000 business people participate in this process.
    Good morning Chairman Johnson, Ranking Member Shelby, and Members 
of the Committee. Thank you for the opportunity to discuss the 
potential impact that additional changes to money market mutual fund 
regulation contemplated by the Securities and Exchange Commission (SEC) 
would have on the business community.
    My name is Brad Fox, and I am the Vice President and Treasurer of 
Safeway Inc. Safeway Inc. is one of the largest food and drug retailers 
in North America with 1,678 stores and $44 Billion in annual revenue at 
year end 2011. We employ approximately 178,000 people in a geographic 
footprint that includes the western and southwestern regions of the 
U.S., the Chicago area and the mid-Atlantic region, with stores locally 
here in the District of Columbia, Baltimore, and Northern Virginia 
areas. I am also a Chairman Emeritus of the National Association of 
Corporate Treasurers (NACT). I am here testifying on behalf of the U.S. 
Chamber of Commerce and the hundreds of corporate treasurers who are 
tasked with managing their companies' cash flows and ensuring that they 
have the working capital necessary to efficiently support their 
operations. I have been active in an advocacy role on money market fund 
regulatory change since the fall of 2009, representing the interests of 
Safeway and the membership of the NACT.
Key Points
    There are several important points that I wish to stress to the 
Committee:

    Money market mutual funds play a critical role in meeting 
        the short-term investment needs of companies across the 
        country. According to May 2012 data from Investment Company 
        Institute, corporate treasurers with cash balances and other 
        institutional investors continue to have confidence in these 
        funds, investing up to $900 billion or approximately 65 percent 
        of the assets in prime money market funds because they provide 
        liquidity, flexibility, transparency, investment diversity, and 
        built-in credit analysis. There are no comparable investment 
        alternatives available in the marketplace today.

    Money market funds also represent a significant source of 
        affordable, short-term financing for many Main Street 
        companies. Approximately 40 percent of all corporate commercial 
        paper in the market place is purchased by these funds.

    Treasurers are extremely concerned that the changes to 
        money market mutual fund regulation would fundamentally alter 
        the product so that it no longer remains a viable investment 
        option. The significance of such a change cannot be overstated. 
        Should it happen, money market mutual funds would no longer 
        remain a viable buyer of corporate commercial paper, which 
        would drive up borrowing costs significantly and force 
        companies to fund their day to day operations in a less 
        efficient manner.

    Some corporate treasures are already making plans to 
        withdraw funds from money market accounts to ensure full access 
        to their funds and avoid the proposed redemption holdback. 
        Also, floating net asset values for money market funds would 
        result in a significant accounting burden for companies across 
        America investing in this product. Most treasury workstations 
        built for managing corporate cash do not have accounting 
        systems to track net asset values (NAVs) on each transfer into 
        and out of money market funds. Putting the systems issue aside, 
        many treasurers would refrain from returning to money market 
        funds to avoid the significant time and effort required to 
        record the gains and losses on each investment and the 
        potential impact on quarterly earnings results. The NACT 
        believes that the SEC must carefully consider whether any 
        additional regulations are required, as the 2010 reforms seem 
        to be working even under the stress of the European sovereign 
        debt crisis. Additional regulations can make the capital 
        markets inefficient and drive up costs harming corporate growth 
        and job creation.
Why Money Market Mutual Funds Are Important
    Money market mutual funds play a critical role in the U.S. economy 
because they work well to serve the investment and short-term funding 
needs of businesses across America. Corporate treasurers rely on money 
market mutual funds to efficiently and affordably manage cash. Cash 
balances for companies fluctuate on a daily, weekly, monthly, or other 
periodic basis, and depending on the nature of the business, some 
companies' cash levels can swing widely--from hundreds of dollars to 
hundreds of millions of dollars. A corporate treasurer's job is to 
ensure that there is sufficient liquidity to meet working capital 
needs, and money market mutual funds are the most liquid, flexible and 
efficient way to do that on the investment side. They are also an 
important source of short term funding.
Money Market Mutual Funds as an Investment
    There are many reasons why money market funds are an attractive 
investment choice in the business community. For companies with cash 
surpluses, money market mutual funds offer a stable $1.00 price per 
share that allows for ease of accounting for frequent investments and 
redemptions. They also offer market rates of return for cash that 
typically get no interest earnings sitting in a commercial bank 
account. Moreover, investments in money market mutual funds can be made 
and redeemed on a daily basis without fees or penalty, providing the 
liquidity needed to manage working capital needs.
    These funds also offer a diversified and expertly managed short-
term investment vehicle. This allows companies to invest in one fund 
while diversifying exposure to a number of underlying investments. 
Additionally, investment advisors to money market mutual funds perform 
the credit analysis of the underlying assets so that treasurers and 
their staffs don't have to spend time and resources analyzing the 
credit worthiness of multiple individual investments, but rather the 
mutual fund itself.
    It is important to note that corporate treasurers understand the 
risk of investing in money market mutual funds. We are professional 
stewards of our companies' cash and we take our responsibility 
seriously. As a large food retailer, we have significant cash inflows 
and outflows on a daily basis that need to be managed efficiently and 
effectively. In the few instances when we have cash to invest, money 
market mutual funds are attractive to us since they are subject to a 
high degree of transparency, which means that we can easily ascertain 
what investments are in each money market mutual fund and the degree of 
risk associated with each fund.
Money Market Mutual Funds as a Financing Source
    Money market mutual funds also represent a major source of funding 
to the corporate commercial paper market in the U.S., purchasing 
approximately 40 percent of all outstanding commercial paper. In April 
2012, U.S. money market mutual funds held $380 billion in commercial 
paper, according to iMoneyNet. This source of financing is vital to 
companies across America as commercial paper is an easy, affordable way 
to quickly obtain short-term financing. Without money market mutual 
funds, the commercial paper market would be substantially less liquid, 
forcing companies to turn to more expensive means of financing. Higher 
financing costs will create a drag on business expansion and job 
creation.
    For example, Safeway is a business with significant swings in 
weekly cash flows, so we have found it most efficient to manage our net 
borrowing position in the commercial paper market. As our working 
capital needs can change over the course of a week by as much as $200 
million, the ability to borrow overnight in the commercial paper market 
allows us to manage our position very efficiently. On a daily basis, we 
collect all of our cash, checks, and payment card receipts from our 
stores. We then review and pay all vendor and other operating and 
capital expenses. The commercial paper position is then adjusted 
accordingly through incremental borrowing or repayment to balance our 
daily books and avoid holding excess cash.
    If instead, we had to use our revolving credit facility with our 
banks for overnight borrowings, those borrowings would be priced at the 
Prime Rate, approximately 2.5 percent higher than where we can place 
overnight commercial paper. To request a more comparable, LIBOR-based 
funding from our bank group would require 3 days advance notice, be for 
a minimum term of 14 days and still be at a rate about 0.25 percent 
higher than our commercial paper for the same term. These borrowing 
restrictions would inevitably lead to over or under-borrowed positions 
because they will rely on longer term forecasts, further driving up 
costs when compared to balancing at the margin using overnight 
commercial paper. Our banks provide these credit facilities to serve as 
backup lines for commercial paper issuance. Their preference is to not 
fund these low-priced credit facilities to investment grade companies, 
and to save their capital for loans to lower rated companies which do 
not have the same access to public markets where they can earn higher 
returns.
2010 Changes to Rule 2a-7
    Before discussing possible further changes in the regulation of 
money market mutual funds, it is important to emphasize that such 
changes will not occur in a vacuum. Just 2 years ago, the U.S. 
Securities and Exchange Commission made enhancements to money market 
mutual fund regulation through Rule 2a-7. These changes greatly 
strengthened these funds, but most importantly, increased their 
liquidity requirements. Funds are now required to meet a daily 
liquidity requirement such that 10 percent of the assets turn into cash 
in one day and 30 percent within one week. This large liquidity buffer 
makes it unlikely that large redemption requests--even at the rate seen 
in the 2008 financial crisis--would force a fund to sell assets at a 
loss prior to their maturity.
    Despite the fact that the 2010 reforms have just been implemented, 
advocates of further regulation have focused much attention on three 
significant structural changes to money market funds--redemption 
restrictions, a floating NAV and a mandatory capital buffer. As 
discussed below, we believe each of these would have a significant 
negative impact on the ongoing viability of these funds, and thereby 
inflict collateral damage on the corporate commercial paper market.
Redemption Restrictions
    There are serious concerns about the SEC's potential implementation 
of redemption holdbacks or other restrictions on the ability to access 
funds invested in money market mutual funds. Some corporate treasures 
are already making plans to withdraw funds from money market accounts 
to have full access to their funds and avoid the complexities of 
monitoring simultaneous holdback positions on multiple transfers into 
and out of money market funds.
    The reasons for this should be obvious. If corporate treasurers 
can't get access to cash investments, they would be forced to seek 
alternative resources to meet working capital needs. This includes 
issuing debt or drawing on our credit facilities, incurring additional 
costs that may be deployed more efficiently elsewhere. Such actions are 
imprudent and illogical. Let me be clear: a corporate treasurer's 
number one priority is liquidity, so any kind of redemption holdback or 
restriction will not work. We would take our money elsewhere.
Floating Net Asset Value
    There are similar concerns among the treasurer community with 
regard to the proposal to establish floating NAVs for money market 
mutual funds. Most treasury workstations built for managing corporate 
cash do not have accounting systems in place to track NAVs on each 
transfer into and out of money market funds. Treasury workstations 
would need to be upgraded to accommodate these changes, and that 
investment would significantly lag behind the timing of implementing 
floating NAVs. As a result, corporate treasurers would likely withdraw 
money market fund investments until the systems issue is solved. On a 
related note, the systems upgrade costs would force a reallocation of 
capital expenditure away from more economically productive uses like 
business expansion and job growth.
    Even putting the systems issue aside, many treasurers would refrain 
from returning to money market funds to avoid having to record the 
gains and losses on each investment that would flow through quarterly 
earnings results. Corporate treasurers diversify fund investments, and 
as such, are typically in multiple money market mutual funds at any 
given time. Tracking the capital gains and losses on each fund where 
investments and redemptions occur frequently is very complex. 
Treasurers currently don't have the manpower (or resources) to track 
this, nor do we have the desire to expend limited resources doing so. 
We would simply find other places for our cash.
    In addition, many treasurers are precluded from investing in 
variable rate instruments. Taken as a whole, the challenges associated 
with investment in floating NAV funds would outweigh the potential 
return for many treasurers.
Capital Buffer
    One other proposal that the Securities and Exchange Commission has 
publicly discussed is the implementation of some type of capital buffer 
in an attempt to protect against losses. While this should sound 
appealing to investors, the reality is it doesn't. If the capital 
buffer is funded by the parent company, due to already thin profit 
margins, it would drive some fund companies out of business, leaving 
fewer choices for investors. Additionally, some costs may be passed on 
to investors. If the capital buffer is built up over time by allocating 
some of the fund's yield to the buffer, it would take too long to build 
the necessary buffer to protect against losses. Similarly, the creation 
of a subordinated class of shares to provide the buffer would require 
additional returns to be paid to those shareholders, and given the near 
zero interest rate environment, this could eliminate any remaining 
returns for investors. Thus, increasing fees or reducing yields is 
likely to deter many investors, including corporate treasurers, from 
investing in money market mutual funds.
Summary/Conclusion
    In summary, Corporate Treasurers are very concerned about a sizable 
contraction of the 2a-7 money market mutual fund industry that is 
likely to result from the changes currently contemplated by the SEC. On 
the investing side, corporations would be forced to withdraw from prime 
money market funds to ensure full access to their money and avoid the 
accounting burden imposed by floating NAVs, and instead invest in less 
flexible bank investment products, other unregulated funds, or 
individual securities. In so doing, they would lose the liquidity and 
risk diversification benefit of the 2a-7 structure and increase 
individual counterparty risk. On the funding side, a decrease in 2a-7 
capacity would lead to higher costs and less liquidity for commercial 
paper issuers, and place greater stress on banks to make up the 
difference with additional lending. There would be greater uncertainty 
in the daily activities of treasury departments, and that uncertainty 
would likely lead to more caution in planning capital investments to 
grow businesses and create jobs.
    Rule 2a-7 money market mutual funds have been the gold standard 
structure around the world for many years. The question must be asked, 
why make additional changes now? With the reforms implemented in 2010 
to provide greater liquidity, safety and transparency, these funds have 
proven to be very stable and attractive investments during a time of 
great upheaval in global markets related to the European sovereign debt 
crisis. Given this stress test and resulting strong performance by 
money market mutual funds, we renew our advocacy position questioning 
whether any further regulation of the money market mutual fund industry 
by the SEC is needed. Altering the structure and nature of money market 
mutual funds would take away a vital short-term cash management tool 
for companies throughout the country.
    Thank you.
                                 ______
                                 
               PREPARED STATEMENT OF DAVID S. SCHARFSTEIN
  Edmund Cogswell Converse Professor of Finance and Banking, Harvard 
                            Business School
                             June 21, 2012
    Chairman Johnson, Ranking Member Shelby, and Members of the 
Committee, thank you for the opportunity to appear here today to offer 
my perspectives on money market mutual fund reform. My name is David 
Scharfstein, and I am the Edmund Cogswell Converse Professor of Finance 
and Banking at Harvard Business School. I am also a member of the Squam 
Lake Group, which is comprised of 13 financial economists who offer 
guidance on the reform of financial regulation. Our group has issued a 
policy brief that advocates the introduction of capital buffers for 
money market funds. I would like to provide a rationale for our 
recommendations, but my statement, though aided by feedback from 
members of the Squam Lake Group, is not being made on its behalf or any 
other organizations with which I am affiliated.
Introduction
    Observers of the first 35 years of money market fund (MMF) history 
might have concluded that MMFs are a relatively safe investment and 
cash management tool with no significant implications for financial 
system stability. But the events surrounding the financial crisis of 
2007-2009 suggest otherwise. When the Primary Reserve Fund ``broke the 
buck'' after the failure of Lehman Brothers, it precipitated large 
redemptions from prime MMFs, mainly by institutional investors who were 
concerned that large MMF exposures to stressed financial firms would 
lead to losses. This ``run'' on prime MMFs added to stresses on the 
financial system at the peak of the financial crisis because large 
banks depend on MMFs for short-term funding. Faced with large 
withdrawals, MMFs were unable to invest in the commercial paper (CP), 
repurchase agreements (repo) and certificates of deposit (CDs) issued 
by large banks, broker-dealers, and finance companies. To stop the run, 
stabilize the money markets, and ease the funding difficulties of large 
financial institutions, the U.S. Treasury had little choice but to 
temporarily guarantee MMF balances.
    While extreme, the events of 2008 point to fundamental risks that 
prime money market funds pose for the financial system. The main points 
that I want to make are as follows:

  1.  Prime MMFs have evolved into a critical source of short-term, 
        wholesale funding for large, global banks. They are now a much 
        less important funding source for nonfinancial firms.

  2.  Prime MMF portfolios embed financial system risk because they are 
        short-term claims on large, global banks. Moreover, during 
        periods of stress to the financial system, some MMFs have 
        actively taken on systemic risk by investing in higher-
        yielding, risky securities in an effort to grow their assets 
        under management.

  3.  The structure of MMF funding embeds financial system risk because 
        MMF shareholders can pull their funds on demand, and have done 
        so en masse when risk is amplified. This in turn creates 
        systemic funding difficulties for large banks that rely on MMFs 
        for their funding.

  4.  The SEC's 2010 reforms are a potentially useful first step in 
        enhancing money market fund stability, but more reforms are 
        needed to reduce risk in the financial system. Requiring 
        capital buffers large enough to meaningfully reduce portfolio 
        and run risk is a desirable next step in MMF reform.
Money Market Funds and Systemic Risk
A. MMFs as an Important Funding Source for Large, Global Banks
    Total MMF assets are almost $2.6 trillion. Of this amount, $1.4 
trillion are in prime funds, down from a peak of over $2 trillion in 
August 2008. Approximately $900 billion of prime MMF assets are in 
institutional funds, and the remainder are in retail funds. 
Importantly, prime MMF portfolios are mainly invested in money-market 
instruments issued by large, global banks--for the most part in CP, 
repo, and CDs. Exhibit 1 lists the largest nongovernment issuers of 
money market instruments held by prime MMFs. \1\ These top 50 issuers 
account for 93 percent of prime MMF assets that are not backed by the 
Government. And 93 percent of these are claims on large global banks, 
most of which (78 percent) are foreign banks. The rest are mostly 
claims on financial firms, including the finance arms of large 
corporations. There are only 2 nonfinancial firms in the top 50 
issuers. Altogether, only about 3 percent of prime MMF assets are 
invested in paper issued by nonfinancial firms. A combination of 
dramatic growth of financial CP, and declining nonfinancial CP issuance 
since its peak in 2000, has meant that MMFs have small exposures to 
nonfinancial issuers. \2\
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     \1\ I am grateful to Peter Crane of Crane Data for providing these 
data.
     \2\ As of the first quarter 2012, there was only $127 billion of 
domestic nonfinancial CP outstanding, down from its peak of over $300 
billion in 2000. Commercial paper is also a much smaller share of the 
liabilities of nonfinancial firms--now just 1.6 percent as compared to 
its peak of 6.5 percent in 2000.
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    Given that prime MMFs mostly invest in money market instruments 
issued by financial firms, it is not surprising that they provide a 
sizable share of the short-term, wholesale funding of large financial 
institutions. A rough estimate is that prime MMFs provide about 25 
percent of this funding. \3\
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     \3\ Here I am defining short-term wholesale funding as uninsured 
domestic deposits + primary dealer repo + financial CP.
---------------------------------------------------------------------------
    Thus, prime MMFs essentially collect funds from individuals and 
firms to provide financing to large banks, which in turn use the 
proceeds to buy securities and make loans. This process essentially 
adds a step in the chain of credit intermediation. The benefit of 
adding this step is that it provides MMF investors with a diversified 
pool of deposit-like instruments with the convenience of a single 
deposit-like account. But the cost is that it adds risk to the 
financial system. Risk is increased because MMFs allow investors to 
redeem their shares on demand, thereby increasing the likelihood of a 
run on MMFs and the banks they fund during periods of stress to the 
financial system. Risk may also be increased because MMFs have 
incentives to chase yield (and risk) in an effort to attract more 
assets. And investors may be willing move assets to a riskier fund 
because they can exit the fund on demand. MMFs and their investors do 
not take into account the full societal costs of the risks they take 
because they do not bear all the costs and because the Government has 
proven willing to support money markets and MMFs during times of 
financial system stress. Indeed, most of the Government interventions 
during the financial crisis were directed at supporting the money 
markets and money market funds. (See Exhibit 2 for a list of these 
interventions.) Regulation of MMFs is needed to reduce excessive run 
risk and portfolio risk.
B. Systemic Portfolio Risk
    In a recent speech, Eric Rosengren, President and CEO of the 
Federal Reserve Bank of Boston, noted that there is considerable credit 
risk in the portfolios of prime MMFs as measured by credit default swap 
(CDS) spreads. \4\ He reported that as of September 30, 2011, 23 
percent of holdings were backed by a firm with a CDS spread between 200 
and 300 basis points, about 10 percent by a firm with a CDS spread 
between 300 and 400 basis points, and almost 5 percent were backed by a 
firm with a CDS spread in excess of 400 basis points. For reference, as 
of September 30, 2011, the average investment grade corporate bond had 
a CDS spread of roughly 145 basis points. \5\ Thus, as of September 
2011, a meaningful fraction of the securities in prime MMFs were issued 
by firms with CDS spreads well in excess those of the safest investment 
grade companies.
---------------------------------------------------------------------------
     \4\ See, ``Money Market Mutual Funds and Financial Stability'', 
speech by Eric Rosengren at Federal Reserve Bank of Atlanta 2012 
Financial Markets Conference, Stone Mountain, Georgia, April 11, 2012. 
http://www.bos.frb.org/news/speeches/rosengren/2012/041112/041112.pdf
     \5\ In particular, the CDX.IG CDS index, which includes 125 
investment grade corporate bonds, had a 5-year CDS spread of 144 basis 
points on September 30, 2011. By contrast, the CDX.HY CDS index, which 
includes 100 high yield bonds, had a 5-year CDS spread of 829 bps. Note 
that these CDS spreads are for bonds with a longer maturity and, in 
some cases, lower seniority than the money market instruments held in 
MMF portfolios, and thus will tend to be riskier. Nevertheless, the 
point is that MMFs can have significant exposures to risky banks.
---------------------------------------------------------------------------
    Importantly, because MMFs own a pool of claims on large financial 
institutions, this credit risk also includes considerable financial 
system risk. If the financial system is under stress, as it was in the 
2 years surrounding the failure of Lehman Brothers in September 2008, 
it manifests itself in short-term funding difficulties, and an increase 
in the risk of money market instruments.
    Moreover, during the financial crisis of 2007-2009, and the more 
recent eurozone sovereign debt crisis, some MMFs actually sought to 
increase risk and yield in an attempt to attract investors and grow 
assets under management in a low interest-rate environment. In 
particular, during the summer of 2007, interest rates on asset-backed 
commercial paper (ABCP) rose dramatically in response to concerns about 
the quality of subprime loans that served as collateral for these 
conduits. Some MMFs responded to this spike in market risk by actually 
increasing portfolio risk, taking on higher-yielding instruments like 
ABCP in an effort to boost returns and attract new investors. Indeed, 
institutional investors proved to be very responsive to higher yields, 
moving assets to MMFs that had increased yields and risk. Exhibit 3, 
based on data used in a 2012 study by Marcin Kacperczyk and Philipp 
Schnabl, shows that MMFs offering the highest yields were able to grow 
their assets by close to 60 percent from August 2007-August 2008, while 
those that did not increase yields by very much saw little or no asset 
growth. \6\
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     \6\ See, Marcin Kacperczyk and Philipp Schnabl, ``How Safe Are 
Money Market Funds?'' Working Paper, Stern School of Business, New York 
University, April 2012. I am grateful to Philipp Schnabl for preparing 
Exhibit 3.
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    Prime institutional funds responded in similar fashion to the 
eurozone sovereign debt crisis. As concerns rose about the exposure of 
eurozone banks to struggling eurozone countries (such as Greece, 
Portugal, Spain, and Italy), yields on instruments issued by these 
banks increased. This created an opportunity for MMFs to increase 
yields and attract assets, albeit with an increase in risk. Indeed, a 
recent study by Sergey Chernenko and Adi Sunderam finds that some funds 
loaded up on the riskier, higher-yielding securities of eurozone banks 
and in the process were able to grow assets. \7\
---------------------------------------------------------------------------
     \7\ Sergey Chernenko and Adi Sunderam, ``The Quiet Run of 2011: 
Money Market Funds and the European Debt Crisis'', Working Paper, 
Harvard Business School, March 2012.
---------------------------------------------------------------------------
    Two important points emerge from these studies. First, some MMFs 
view it as in their interest to chase risk in an attempt to increase 
yields and grow assets even though such risk-taking could threaten the 
viability of the fund, trigger runs at the fund and other ones (as 
later happened with the Reserve Primary Fund), and ultimately threaten 
the stability of the broader financial system. Second, institutional 
investors can be extremely yield sensitive and risk tolerant; they 
appear willing to move large sums to increase returns by 10 or 20 basis 
points. In part, this may be because they get some measure of 
protection from the option to redeem their shares on demand. But when 
they protect themselves in this way, they exacerbate the stress on MMFs 
and they threaten the ability of MMFs to fund the activities of the 
banking sector.
C. Systemic Funding Risk
    As just noted, the funding structure of MMFs creates risks for the 
broader financial system. Because MMF shares are demandable claims--
they allow investors to redeem their shares on a daily basis--investors 
can pull their funds from MMFs at the slightest hint of trouble. 
Funding risks are also amplified by the fact that MMFs are allowed to 
maintain a stable $1 NAV per share using amortized cost accounting and 
rounding. This enables investors to redeem their shares at a $1 share 
price even if the marked-to-market value is less than $1 per share. The 
stable NAV feature creates incentives for investors to beat other 
investors out the door before the fund breaks the buck and is no longer 
allowed to redeem shares at the $1 share price.
    A run is not just damaging to the MMF, but it could be damaging to 
the broader financial system. A run at one MMF could precipitate runs 
on other MMFs if, as one might expect, investors are concerned that the 
factors that led to losses in one fund could affect other funds. In 
this case, multiple funds will have difficulty rolling over the 
securities in their portfolio, amplifying the funding stresses on 
financial institutions, which can spill over into the real economy. It 
is altogether possible that an otherwise healthy bank will face funding 
difficulties because the failure of another bank leads to a run on the 
MMF sector.
    A systemic MMF run has occurred twice in the last 4 years. As shown 
in Exhibit 4, the failure of Lehman Brothers in September 2008 
precipitated a run on prime institutional MMFs, with assets falling by 
29 percent within 2 weeks. There was no run on prime funds by retail 
investors. The run would likely have been much more severe had Treasury 
not stepped in and temporarily guaranteed MMF balances.
    A similar, but slower-moving version of this story played out in 
the second half of 2011, as prime institutional MMF investors became 
concerned about the exposure of European banks to the sovereign debt of 
struggling eurozone countries. Given the large presence of money market 
instruments issued by eurozone banks in the portfolios of U.S. MMFs, 
this led to significant redemptions from prime institutional MMFs from 
June-December 2011, as shown in Exhibit 4. Again, the redemptions were 
more pronounced among institutional investors than retail investors. 
This is consistent with research showing that it is institutional 
investors that are more prone to chase yield and risk, and then pull 
their funds when their perspectives on risk change. \8\ MMF outflows 
have added to the stresses on eurozone banks, particularly on their 
ability to fund their dollar loans both here and abroad.
---------------------------------------------------------------------------
     \8\ Kacperczyk and Schnabl, op. cit.
---------------------------------------------------------------------------
Regulatory Reform Alternatives and the Need for Capital Buffers
    The broad goal of money market fund regulation should be to ensure 
that portfolio risk and funding risk are within acceptable limits. 
Regulation can take a variety of forms to achieve this objective. 
Portfolio risk can be limited by placing restrictions on what MMFs can 
hold in their portfolios, or by reducing the incentives of MMFs to take 
excessive risk. Funding risk can be limited by reducing the ability of 
shareholders to redeem their shares on demand, or by reducing their 
incentives to do so.
    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. \9\ While these reforms may, in fact, be helpful in 
reducing portfolio and funding risk, SEC Chairman Mary Shapiro is right 
to point out that more needs to be done. \10\ While 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. \11\ Moreover, 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. \12\
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     \9\ See, for example, ``Response to Reported SEC Money Market 
Funds Proposals'', Investment Company Institute, February 17, 2012.
     \10\ SEC Chairman Schapiro is quoted as saying, ``While many say 
our 2010 reforms did the trick--and no more reform is needed--I 
disagree. The fact is that those reforms have not addressed the 
structural flaws in the product. Investors still have incentives to run 
from money market funds at the first sign of a problem.'' See, Sarah N. 
Lynch, ``SEC Schapiro Renews Call for Money Fund Reforms'', Reuters, 
March 15, 2012.
     \11\ See, Morgan Ricks, ``Reforming the Short-Term Funding 
Markets'', The Harvard John M. Olin Discussion Paper Series, No. 713, 
May 2012.
     \12\ In particular, the Tri-Party Repo Task Force established by 
Federal Reserve Bank of New York has recommended that dealers should 
shift to longer-term repo funding. See also ``Basel III: International 
Framework for Liquidity Risk Measurement, Standards and Monitoring,'' 
Bank for International Settlements, December 2010, for a description of 
international regulatory initiatives to reduce bank dependence on 
short-term funding.
---------------------------------------------------------------------------
    Additional 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. \13\ Some 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.
---------------------------------------------------------------------------
     \13\ Ricks, op. cit.
---------------------------------------------------------------------------
    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. First, it would reduce the benefits of early redemptions 
from a stressed fund since redemptions would occur at market values 
rather than an inflated $1 NAV. Second, it would likely make clear to 
investors that MMFs are risky investment vehicles and it would provide 
a more transparent view of the risk. This could help to dampen the sort 
of yield-chasing behavior we have recently observed, followed by the 
runs that occur during a crisis. Thus, the floating NAV proposal, while 
mainly acting to reduce funding risk, could also help to reduce 
portfolio risk.
    The MMF industry has strongly opposed floating NAVs, arguing that 
investors derive significant operating, accounting, and tax management 
benefits from the ability to transact at a fixed price. \14\ While 
there may be benefits of such a pricing structure, it is unclear how 
much of the institutional demand for MMFs derives from such a 
structure. After all, many large institutional investors manage their 
own pool of money market instruments, which of course fluctuate in 
value. It is possible that a good deal of MMF demand comes from the 
higher yields they have historically been able to offer, combined with 
the potential benefits of being able to diversify across money market 
instruments. These benefits would continue to exist in a floating NAV 
structure.
---------------------------------------------------------------------------
     \14\ See, ``Report of the Money Market Working Group'', Investment 
Company Institute, March 17, 2009.
---------------------------------------------------------------------------
    Another concern is that floating NAVs might not be sufficient to 
stop runs in times of stress. Advocates of floating NAVs believe that 
the fixed NAV structure is the attribute of MMFs that significantly 
exacerbates run incentives. An alternative view is that runs derive 
from a change in investor perception of risk combined with their 
ability to redeem shares on demand regardless of whether the redemption 
occurs at $1 or slightly less. Indeed, given the illiquidity of 
securities in MMF portfolios, mass selling of those securities could 
drive down their price. The prospect of fire sales also gives MMF 
shareholders incentives to exit early and could precipitate a run. One 
MMF industry study has pointed out that floating-NAV instruments, such 
as ``ultra-short'' bond funds and certain French floating-NAV money 
market funds were not immune from substantial sudden redemptions during 
the financial crisis. \15\ If so, then some form of a capital buffer 
could be a more effective run-prevention mechanism.
---------------------------------------------------------------------------
     \15\ Ibid.
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Capital Buffers
    The Squam Lake Group, of which I am a member, has proposed capital 
buffers as a mechanism for promoting more stable MMFs. \16\ The policy 
brief outlines a number of possible ways that capital buffers could be 
structured and suggests that individual MMFs be given some flexibility 
in choosing the precise form of the buffer. For example, some sponsors 
may prefer to set aside their own capital, while others may prefer to 
issue a subordinated, loss-absorbing share class. While some choice may 
be desirable, it will be necessary to restrict the menu of options so 
that investors can readily assess the degree of capital support.
---------------------------------------------------------------------------
     \16\ ``Reforming Money Market Funds: A Proposal by the Squam Lake 
Group'', January 14, 2011.
---------------------------------------------------------------------------
    With a capital buffer, first losses are incurred by capital 
providers, either fund sponsors or subordinated share classes. This 
reduces the incentive of MMF investors to run because they can be more 
confident that their investment is protected. A capital buffer could 
also act to reduce portfolio risk. If the sponsor provides the capital, 
the sponsor would presumably have greater incentives than it does now 
to avoid losses. Even if capital is provided by a subordinated share 
class, sponsors would have incentives to reduce portfolio risk to limit 
the cost of this capital and increase yields on the senior share 
classes.
    Although capital buffers may seem like a significant departure from 
the current regime, MMF sponsors have often provided capital support 
when necessary. As documented recently by Eric Rosengren, fund sponsors 
provided capital support in 56 instances from 2007-2010. In nine cases, 
support exceeded 1 percent of net asset value. \17\ However, capital 
requirements are preferable to ad hoc capital support because with 
capital requirements investors will know that there is layer of capital 
support to protect them; if capital support is ad hoc, investors will 
run in the face of uncertainty about whether support will be 
forthcoming.
---------------------------------------------------------------------------
     \17\ Rosengren, op. cit.
---------------------------------------------------------------------------
    There is also active debate about what the right level of capital 
should be. Industry advocates suggest relatively low levels of capital 
given historical loss rates. However, it is important to set capital 
levels comfortably above historical loss rates and prior levels of ad 
hoc capital support so that investors are confident that their funds 
are safe and have no incentive to run. In addition, historical loss 
during the crisis of 2007-2009 occurred against the backdrop of 
extraordinary Government support of the money markets and money market 
funds. Without such support, which may not be forthcoming to the same 
degree in the next crisis, loss rates could well be higher than the 
historical crisis average. For these reasons, capital buffers would 
need to be set meaningfully in excess of historical loss rates and ad 
hoc capital support levels.
    Finally, the MMF industry has generally opposed capital buffers, 
arguing that they are costly and would make MMF sponsorship 
unprofitable. While there are costs of a capital buffer, the costs 
should not be particularly high if, as industry opponents argue, MMFs 
are relatively safe. \18\ Moreover, as discussed above Moreover, 
capital is also costly to banks, and yet there is widespread agreement 
that they should hold capital. Like banks, MMFs are systemically 
significant financial intermediaries and as such should have capital 
buffers to promote a more stable financial system.
---------------------------------------------------------------------------
     \18\ For example, suppose there was a capital buffer that required 
sponsors to set aside 2 percent of NAV in Treasuries. Sponsors would 
have to pay a liquidity premium for holding Treasuries. This liquidity 
premium is on the order of 1 percent. With a 2 percent buffer, this 
cost amounts to just 2 basis points. The potentially greater cost comes 
from the possibility that the sponsor loses the capital as compared to 
a situation where the sponsor just walks away from the fund. If the 
risk is low, this cost should be minimal. Note also that many sponsors 
choose to support their funds when they risk breaking the buck, so 
relative to such noncontractual support the cost of the buffer is even 
lower.
---------------------------------------------------------------------------
    Thank you for the opportunity to present my views on money market 
fund reform. I look forward to answering any questions you may have.


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              Additional Material Supplied for the Record
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LETTER SUBMITTED BY MICHELE M. JALBERT, EXECUTIVE DIRECTOR--POLICY AND 
                   STRATEGY, THE NEW ENGLAND COUNCIL



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PREPARED STATEMENT SUBMITTED BY JEFFREY N. GORDON, RICHARD PAUL RICHMAN 
PROFESSOR OF LAW AND CO-DIRECTOR, CENTER FOR LAW AND ECONOMIC STUDIES, 
                          COLUMBIA LAW SCHOOL



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