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Did Dodd-Frank doom MMFs?

By Sheyna Steiner ·
Wednesday, June 15, 2011
Posted: 11 am ET

Remember back in 2008 when the net asset value of one money market mutual fund dipped below $1? The Reserve Primary fund broke the buck in September of 2008 in the wake of the Lehman Brothers implosion. Now money market funds could be looking at a similar scenario, this time thanks to events across the pond.

A story in The New York Times on Sunday, June 12, "In Greece, some see a new Lehman," reported on the ever-unfolding Greek debt situation and the potential fallout from a default.

From the story:

According to a recent report by Fitch, as of February, 44.3 percent of prime money market funds in the United States were invested in the short-term debt of European banks. Some of those institutions, like Deutsche Bank and Barclays, do not have dangerous Greek exposure. But some of those funds also hold shares of French banks like Société Générale, Crédit Agricole and BNP Paribas, which do have significant Greek bond holdings -- about 8.5 billion euros, or, in the case of BNP and Société Générale, about 10 percent of their Tier 1 capital.

This month, the president of the Federal Reserve Bank of Boston, Eric S. Rosengren, warned that the large share of European banks in American money market fund portfolios posed a Lehman-like risk if, in the wake of a default in Europe, panicky investors took their money out all at once.

So, a Greek default could touch off a domino effect that could culminate in a dip in share price in very safe money market funds. Though there is no guarantee, money market funds keep a share price of $1 and are tightly regulated in the types of investments they can hold and the amount of cash or cash equivalents the fund must keep in order to keep that consistent NAV.

A recent article on the website, "Greek default threatens money market run that Treasury may be unable to halt this time," brought up the question of what the Treasury will be able to do in case money market funds flounder once again.

Back in 2008, the Treasury was able to bail out money market funds with a temporary guaranty program, insuring the holdings of eligible money market funds for one year.

The Dodd-Frank Wall Street Reform Act closed the bailout barn door in many ways. In this case, it sealed off the avenue by which the Treasury rescued money market funds.

It's explained in a 2010 article from TPM by Brian Beutler, "Could the Wall Street reform bill make the U.S. more susceptible to financial collapse." (Hat tip to Thinkprogress' TP Yglesias)

From the article:

Under the terms of the Wall Street reform bill, a company like Lehman Brothers would be put through resolution, meaning its investors -- including money market funds -- would take substantial hits as the firm gets liquidated. At the same time, according to Elliott and others, the government will be unable to prop up the funds in the event of another run, because the bill also eliminates that authority. That means the same companies that teetered on the edge of bankruptcy in the midst of the Lehman collapse will no longer have a safety net.

Last August, Moody's released a report that revealed that Reserve Primary wasn't the only money market fund to struggle in 2008. But many of the money market funds that did stumble were propped up by their sponsor or parent companies. If the economic environment is not favorable for that kind of parent company investment again, money market funds may not have that support either.

As with any investment, investors should fully understand the risks and benefits before jumping in. Unless an investment comes with an explicit guarantee, anything can happen, past performance is not indicative of future results and your mileage may vary.

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