The Federal Reserve is not waiting to see flames before hosing down corners of the money market with emergency liquidity.
Late Wednesday night, the central bank launched the Money Market Mutual Fund Liquidity Facility, a program designed to inject cash into some of the safest investment vehicles available. Like other emergency action to keep credit flowing as America hunkers down from the coronavirus, it’s a re-run of the Fed’s crisis-era moves in 2008. But this time, policy makers acted well before pressure on funds reached a desperate stage.
“We were seeing some prime funds facing more liquidity issues,” Eric Rosengren, president of the Boston Fed, said Thursday in an interview with Bloomberg News. “Rather than wait until the problem became critical we thought it was important to help provide some liquidity. The goal was to nip this in the bud.”
Prime funds are those money funds eligible to invest in debt not backed by the U.S. government. They hold about $1 trillion of the $4.2 trillion industry, according to Crane Data LLC. Most of the rest is parked in funds dedicated to short-term Treasuries and other government-backed debt, with a small fraction invested in short-term municipal debt.
A record $249 billion poured in to government-only funds in the week through March 18, according to the Investment Company Institute. Prime funds saw $85.4 billion in outflows.
The new facility, administered by the Boston Fed, will make risk-free loans to banks. The banks will use the money to buy assets out of prime money funds and deposit those assets at the Boston Fed as collateral.
The program will accept both asset-backed and unsecured commercial paper, as well as government-backed debt and receivables from certain repurchase agreements. The 2008 version accepted only asset-backed commercial paper.
The aim is generally the same as during the last crisis: to make it easier for companies to issue short-term debt in a time when investors increasingly hoard cash.
Deborah Cunningham, chief investment officer for global money markets at Federated Hermes Inc. in Pittsburgh, said institutional clients across the industry were gradually withdrawing money from prime funds, forcing the funds to sell holdings into the secondary market.
Institutional money market funds no longer maintain a stable $1 net asset value, so they can no longer “break the buck” by falling below that level, but they do strive to maintain minimum liquidity thresholds — proportions of their funds that will mature in less than seven and thirty days.
“Every day this week we have been selling securities to help maintain that cushion, yet every day this week the cushion has been getting smaller,” she said. “That brought fund managers, including ourselves, to a point where we were uncomfortable.”
The renewal of a money fund liquidity facility is likely to resuscitate the discussion over how money funds should be regulated.
Following the 2008 debacle — when the Reserve Primary Fund broke the buck in the aftermath of the collapse of investment bank Lehman Brothers, intensifying the global crisis — that debate lasted eight years before new rules were imposed.
Those rules segregated retail investors from faster-moving institutional money and forced the industry to abandon the $1 share for institutional funds that invest in non-government debt. The funds industry succeeded, however, in blocking even more drastic proposals.
The 2016 changes did reduce the amount of money in prime funds, a very positive outcome, Rosengren said. Including retail prime funds, they hold about $1 trillion, according to Crane. In 2008, those funds held more than twice that.
Rosengren said money fund assets should be even more heavily concentrated in government-only funds.
“People seem to be quite comfortable that government funds will be able to meet their liquidity needs,” he said. “We’re not seeing runs on government funds.”
(Updates with money fund flows in fifth paragraph.)
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