April 11, 2012

Money market funds must be thoroughly revamped in order to ensure a stable U.S. financial system, the president of the Federal Reserve Bank of Boston, Eric Rosengren, said on Wednesday.

Rosengren said reforms to date, including restrictions from the Securities and Exchange Commission, are not sufficient to rid the $2.6 trillion money fund industry of considerable exposure to risky corners of financial markets.

The fund industry came under scrutiny in the wake of the financial crisis after the failure of Lehman Brothers led to paralysis in short-term money markets.

"More substantial initiatives are needed to reduce the risks to financial stability," Rosengren said in remarks prepared for delivery at a conference on financial stability sponsored by the Atlanta Fed.

"The SEC limitations placed on credit risk are currently too broad to avoid significant credit risk exposure," he added.

The SEC itself has been pressing for stricter measures to regulate the money fund industry, but SEC Chairman Mary Schapiro has so far not been able to gain enough support within the commission to further reforms.

The money fund industry has mounted strong opposition to greater regulation.

Rosengren argued that while the industry had reduced its exposure to European sovereign debt, it could still be a possible conduit for risks associated with the continent's financial institutions to make their way into the U.S. banking system.

At the end 2011, he said, 36 percent of money market fund assets remained invested in European securities.

Moreover, Rosengren argued that the market for securities used to insure against default suggested many investors are still very concerned about such risks when it comes to money market funds.

Rosengren said there were two main ways to deal with the problem: either force funds to hold capital or do away with the industry's standard of offering a fixed net asset value to reflect actual fluctuations in market risk.

Both approaches carry costs, he said, but are necessary steps to ensure the soundness of the financial sector.

"The risks to the stability of the financial system that underpins the economy are too great not to take the actions that will make the industry, and our financial system, more stable," he said.

Systemic risks posed by money funds were highlighted during the financial crisis in 2008 when the Reserve Primary Fund saw its net asset value fall below the standard level of $1, a circumstance known as "breaking the buck." The move caused the Federal Reserve to step in with emergency liquidity lines, and some money funds required millions of dollars in support from their parent firms. (Editing by Leslie Adler)

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