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Looking back at 2010, it was another stressful and eventful year for money market mutual funds. The year began with the SEC'​s Money Market Fund Reforms, the most recent round of changes to Rule 2a-​7 of the Investment Company Act of 1940 and ended with the release of the President'​s Working Group Report on further "​Money Market Fund Reform Options". In between, the news was punctuated with liquidations and outsourcing, asset declines, and plenty of debate over the future of money market funds. Below, we excerpt from some of the highlights in Crane Data'​s News during 2010.

On January 27, we wrote "SEC Approves Money Market Fund Reform Proposals, Hosts Webcast," which said, "This morning, the SEC voted to approve its Money Market Reform Proposals.... A released summary statement says, 'The Securities and Exchange Commission today will consider adopting new rules designed to significantly strengthen the regulatory requirements governing money market funds. The rules will, if adopted, increase the resilience of these funds to economic stresses and reduce the risks of runs on the funds.... The rules would improve liquidity, increase credit quality and shorten maturity limits. They also would enhance disclosures by, among other things, requiring the posting on a delayed basis of a fund'​s '​shadow' net asset value or NAV.'"

On Feb. 24, Crane Data featured, "SEC Posts Full Final 220-​Page Text of Money Market Fund Reforms," which said, "​The summary says, 'The Securities and Exchange Commission is adopting amendments to certain rules that govern money market funds under the Investment Company Act of 1940. The amendments will tighten the risk-​limiting conditions of rule 2a-​7 by, among other things, requiring funds to maintain a portion of their portfolios in instruments that can be readily converted to cash, reducing the maximum weighted average maturity of portfolio holdings, and improving the quality of portfolio securities; require money market funds to report their portfolio holdings monthly to the Commission; and permit a money market fund that has '​broken the buck', or is at imminent risk of breaking the buck, to suspend redemptions to allow for the orderly liquidation of fund assets. The amendments are designed to make money market funds more resilient to certain short-​term market risks, and to provide greater protections for investors in a money market fund that is unable to maintain a stable net asset value per share."

Other Crane Data News stories of note throughout the first half of 2010 included: "ICI'​s Stevens Defends $​1 NAV, Reveals Liquidity Facility Blueprint," which said, "ICI President & CEO Paul Schott Stevens strongly defended the money market mutual fund industry and its $​1.​00 NAV standard, and revealed that the ICI is pursuing the challenge of a '​stronger liquidity backstop' for the industry;" "Money Fund Assets Fall Below $​3 Trillion, First Time Since Oct. 2007," which says, "Money market mutual fund assets fell below the $​3.​0 trillion level for the first time since October 31, 2007;" and, "`​New Securities Appear to Address MMF Reform 7-​Day Liquidity Bucket," which says, "A new type of money market security began appearing last week designed to address both the recent SEC Money Market Fund Reform liquidity mandates and concerns about European debt with longer maturities."

During the second half, we featured: "Federated to Take Over SunTrust'​s RidgeWorth Money Mkt Fund Assets," which quoted a press release, "Federated Investors, Inc., one of the nation'​s largest investment managers, reached a definitive agreement with SunTrust Banks, Inc. to transition approximately $​17 billion in money market assets to Federated;" "Moody'​s Proposes New Money Market Fund Rating Methodology, Symbols;" and, "Liquidations Continue in Money Fund Space; Neuberger Files to Quit," which said, "Neuberger Berman appears to be the latest casualty of ultra-​low rates, asset outflows and rising regulatory requirements in the money market mutual fund space."

In late October we wrote, "President'​s Working Group on Financial Mkts Gives MMF Reform Options." This article said, "The U.​S. Treasury has released its long-​awaited '​Report of the President'​s Working Group on Financial Markets: Money Market Fund Reform Options,' a paper '​detailing a number of options for reforms related to money market funds. These options address the vulnerabilities of money market funds that contributed to the financial crisis in 2008.... Treasury'​s press release says, 'Following the crisis, the Treasury Department directed the PWG to develop this report to assess options for mitigating the systemic risk associated with money market funds and reducing their susceptibility to runs. The PWG agrees that, while a number of positive reforms have been implemented, more should be done to address this susceptibility. The PWG now requests that the Financial Stability Oversight Council (​FSOC), established by the Dodd-​Frank Wall Street Reform and Consumer Protection Act, consider the options discussed in this report and pursue appropriate next steps."

Finally, our News continued, "[​T]​he Securities and Exchange Commission, as the regulator of money market funds, will solicit public comments.... Today'​s release is one part in a series of steps that the regulatory community will be taking in the coming months to implement financial reform and to help ensure that the financial system continues to become more resilient.... [​U]​nder '​Policy Options,' the report discusses, Floating net asset values; Private emergency liquidity facilities for MMFs; Mandatory redemptions in kind; Insurance for MMFs; A two-​tier system of MMFs with enhanced protection for stable NAV funds; A two-​tier system of MMFs with stable NAV MMFs reserved for retail investors; Regulating stable NAV MMFs as special purpose banks; and Enhanced constraints on unregulated MMF substitutes."

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Early this month, BofA Global Capital Management, the new name for Bank of America'​s former Columbia Management money fund unit, posted market commentary on their website entitled, "Translating QE2 into Higher Returns on Cash Portfolios." The update, which is subtitled, "Second Round of Fed Easing Presents an Opportunity for More Aggressive Cash Investors," says, "The U.​S. Federal Reserve'​s decision to purchase $​600 billion of U.​S. Treasuries over the next year might or might not succeed in quickening the pulse of the U.​S. economy, but it has the potential to benefit cash investors willing to accept a modest increase in risk to achieve higher returns."

The piece explains, "The opportunity presented by the second round of quantitative easing, known formally as Large Scale Asset Purchases (​LSAP) and informally as QE2, stems from the drop in Treasury yields LSAP is likely to trigger. By increasing demand for Treasuries, LSAP should push down already anemic Treasury yields. That, in turn, should drive up demand for spread product, such as corporate bonds and asset-​backed securities (​ABS), which historically have outperformed Treasuries. The increased demand for these asset classes likely would drive up their prices, creating an opportunity for investors who buy at the right time."

The manager of the BofA Funds continues, "Of course, rising prices of spread product would lower the instruments' yields, which is not optimal for income-​oriented investors who buy too late in the easing cycle. However, for those who get the timing right, price increases for ABS, corporates, mortgage-​backed securities (​MBS), etc. potentially could generate attractive total returns if those investors pursue a buy-​and-​hold strategy."

It says, "Holding the assets is necessary to capture the opportunity presented by LSAP because: Holding the structured product could enable the investor to fully exploit the potential increase in the value of the bonds as the Fed implements QE2.... Short-​duration bonds historically have drawn the lion'​s share of their total return from '​carry,' i.​e., the clipping of coupon during the holding period.... Investors who hold their short-​term debt also may benefit from the '​roll down the curve.' In a normal, upward-​sloping yield curve environment, bonds increase in value as time passes because as their maturities shorten, the bonds' yields fall and their prices rise."

The paper also says, "To benefit from the potential increase in demand for spread product, cash investors need to be comfortable with the risk/​reward profile of these assets. Spread product historically has outperformed government debt, but it also carries more credit risk. In addition, investors must be willing to go farther out the yield curve because the Fed is targeting two- to 10-​year Treasuries, which means cash investors would need to purchase spread product that falls within that part of the yield curve. Naturally, extending the duration of their portfolios would expose them to higher interest rate risk."

BofA Global comments in a section entitled, "Another Reason to Consider Separate Accounts," "Investors in money market funds cannot benefit from the potential flight to spread product because the maturities of money market fund credits cannot exceed 397 days. In addition, funds cannot invest in some spread product because federal regulations prohibit the inclusion of these higher-​risk assets in fund portfolios. As such, investors interested in capturing the benefits that might accrue from LSAP need to consider an alternative to money market funds: the separately managed account."

Finally, they add, "Customized to the risk tolerance and objectives of each investor, a separate account can hold debt with maturities that extend beyond those of money market fund investments. Moreover, separate account strategies can invest in the full array of debt instruments available to cash investors. This flexibility enables cash investors to fully exploit not only the opportunities that may arise from the latest round of Fed easing, but also from any other change in the market environment. When selecting a separate account manager, it behooves the investor to assess firms' experience managing separately managed accounts as well as their ability to manage risk, the latter being particularly important for investors who intend to pursue a more aggressive investment strategy."

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Yesterday, we excerpted from our latest monthly "​fund profile" in the December issue of our flagship Money Fund Intelligence newsletter. We interviewed Creston King of Davis Selected Advisers, manager of the Davis Government Money Market Fund. Below, we reprint excerpts from the second half of our Q&​A with the Government fund portfolio manager.

King tells MFI, "​Occasionally, I see some Government guaranteed agency paper that is short enough to be included in the portfolio. We might participate in this, because we have the ability to pick up the crumbs, where the bigger shops aren'​t going to waste their time.... We are willing to trade smaller pieces because we have smaller portfolios."

"​Some of these are 100% guaranteed by the U.​S. Government. Fannie and Freddy are right now, but Farm Credit and Home Loan are not. There are government agencies or government sponsored enterprises. It isn'​t implied backing. But if you get a bond, for instance, that is 397 days to maturity or less, you might pick a smaller piece of that. Someone in the trust department area of a bank might say, '​Hey, look, this is a cash instrument. Let'​s get out of it and do something different.' We can pick that up at an advantageous yield because not many other people are willing to pick up that kind of paper," says King.

Q: Have you guys ever gone outside of the government agencies? He tells us, "We looked at going into FDIC paper. But we got back to the Davis thinking on that, which is, '​Yes we can. However we are picking up just a few bps. It'​s not worth risking our reputation to go after a few extra basis points. Let'​s just stick to what we are doing here and stay in the safer positions.'"

Q: What'​s your outlook for the Fed & rates? King says, "​Perhaps it is wishful thinking, but I'​m thinking we might see some increase in rates in the late second quarter or early third quarter. I don'​t know that the Fed will actually come in and do something, but perhaps there will be some improvement in the economy that is evident.... [​But] we really don'​t see the Fed doing anything really all throughout next year, although I am hoping that there is some change by midyear.... I am hoping that there is some increase in that help to push rates up. I have a hard time buying right now 1-​year paper yielding in the 20s."

Q: How about your tolerance for fee waivers? King answers, "We'​ve been approached by people asking us, '​Do you want us to manage your fund for you?' The response from senior management here was, 'No, absolutely not.' [​But] we have been writing some substantial checks over the past number of months to basically keep us at zero yields."

Q: Are you using any other strategies to survive like pushing the WAM up against the limit or cutting expenses? He answers, "The WAMs have become so short that it'​s hard to get there. At ninety days you could do some positioning. But now you ... start to bump up against things quickly ... That is why I wouldn'​t be surprised to see some guys ... flip the switch here and play just outside of money market range. And we may be headed towards that if we actually do go to the floating NAV."

Q: Any predictions on the future? King says, "​I thought if we could get through 1994 we could get through anything. But here we are in the land of no yield.... I don'​t know ... where are we headed or how quickly we are going to get there. But I think, currently, we are still of the mind that we [​will] keep it going. But at some point this is going to have to change.... On the plus side, there is still a ton of cash sitting on the sidelines in this market, because there is so much uncertainty as to what can happen and might happen."

Q: Are there any other secrets to competing as a small shop? King tells us, "In my career it'​s been about maintaining relationships. One of the things that we do is look at small positions in traders' inventories. Sometimes we can obtain higher yields on the small positions. I have found this helps to keep us on the dealers' radar and perhaps help us to get an extra call every now and then."

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Earlier this month, Money Fund Intelligence interviewed Creston King, portfolio manager at Davis Selected Advisers, which manages the Davis Government Money Market Fund, offered to buyers of the Davis series of equity funds, and the Selected Daily Government Fund, used for the company'​s no-​load fund series. Both money funds are 100% exclusively '​government.' King has been managing money funds since 1994 and has been with Davis since 1999, and Davis has offered their funds since the late 1980'​s. We excerpt the first half of our Q&​A below.

Q: Have Government money funds had any problems during the recent crisis? King tells us, "​No, they haven'​t. That'​s one of the things I'​ve railed against a little bit here.... All of these regulations are being written for prime funds. I don'​t like them. I think they are not appropriately written. Many of them should only be applicable to prime, but we'​re supposed to apply them to the government sector as well. So we'​ve had a fun time engineering things so that they would be appropriate for government as well. [​But] we are a small sector of the entire money fund universe, so I really don'​t see how we are going to get anything changed."

Q: Did Davis choose to have just Government funds because of safety concerns? Or were you just lucky? He answers, "Yes, they choose to have them because of safety. Founder Shelby Davis used to call bonds '​certificates of confiscation.' We don'​t want to have anything risky.... The reason behind it is that we want our customers to take risk in the equity funds. We don'​t want them to take risk in the bond fund or money fund."

Q: What'​s your biggest challenge? King tells us, "Well, recently I would say it'​s been complying with the [​SEC'​s] 30% liquidity rule.... We went through the transition earlier in the year to [​learn] kind of how it works and to structure the portfolio. One of the things we'​ve done is just ... maintain that [​large repo] position.... [​Our] portfolio is probably a higher percentage of repo than it'​s been in a long time."

Q: Have there been additional reporting challenges? King responds, "We designed our own spreadsheet and monitor weighted average maturities and the weighted average life of the portfolio to take into account the floating rate maturities. We did go to State Street and get them to do stress testing for us. One question is, '​Why does a treasury fund not have to do stress testing and a government fund does?' I don'​t think there is that much difference. Certainly, in this particular environment, let'​s just look at it right now, Fannie and Freddie are 100% guaranteed by the US government.... I don'​t know if they are going to remove that at some point, though I think they probably will."

Q: Can you talk about how the WAL has impacted your portfolio? He tells us, "Yes, we won'​t buy [​floaters] longer than 13 months.... You can buy a 2 year [​final maturity floater]. I ... could buy those 2 years but have to write them up and get them approved by showing why we believe that it'​s going to reset at amortized cost.... [​T]​he other thing is ... that is going to push the weighted average life out a lot more quickly."

Q: Tell us about the Government agency security market and supply. King explains, "The big names of course are Fannie Mae and Freddie Mac, Federal Home Loan Bank and Federal Farm Credit Bank. After that there is Farmer Mac, which is considered a lesser agency. I have never personally bought it, but I'​ve seen it offered and traded every day. After that you can get into your smaller securities that are out there.... We are not as much into that market as [​we are] Fannie, Freddie, Home Loan and Farm Credit."

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The first substantial comment letters on the President'​s Working Group Report on Money Market Fund Reform (​Request for Comment) were recently posted to the SEC'​s website. (Click here to see the comment letters.) In what'​s sure to be a common theme when the bulk of comment letters get posted around the January 10 deadline, the National Association of State Treasurers spent its letter strongly opposing a floating NAV. Meanwhile, consulting firm Treasury Strategies took another opportunity to reiterate its opposition to Moody'​s recent ratings change proposals.

James Lewis, President of the National Association of State Treasurers writes, "The National Association of State Treasurers (​NAST), the organization that represents the treasurers or chief financial officers of the fifty states, the District of Columbia, and Puerto Rico, wishes to go on record as opposing the proposal of the President'​s Working Group on Financial Markets that money market funds (​MMFs) maintain a floating Net Asset Value (​NAV), rather than a stable $​1 per share as has been the standard. NAST believes that such a change would not be in the interests of either investors or debt issuers and could potentially destabilize the market."

The letter continues, "NAST further believes that a floating NAV could decrease investor demand and transform money market funds into, essentially, short-​term bond funds. If this were to occur, it would negatively impact the current money market fund benefits by: Increasing investment risk, especially in volatile market conditions. Money market funds are currently well regulated by the SEC (​Rule 2a-​7). Money market investors understand there is some relatively small level of risk; Eliminating daily liquidity and lengthening the time to obtain cash; Increasing fund administrative costs, thereby decreasing net yield; Reducing diversification and perhaps even precluding certain public investors from using floating NAV money market funds."

It adds, "In addition, NAST believes that a floating NAV would push investors to less regulated or non-​regulated markets increasing risk and increase accounting requirements of investors (​e.​g., mark-​to-​market). Finally, NAST believes that the floating NAV would reduce or eliminate a market for short-​term public and non-​profit debt. A floating NAV could lead to a contraction in short-​term public financing capability as investors, especially institutional investors, move to other products. It would also increase short-​term debt costs for states due to the reduction of placement options."

Finally, they write, "NAST has previously commented on some of the negative aspects of a floating NAV, and the organization still believes that it is a bad idea whose adoption would not have a positive result for either investors or debt issuers. It does not accept the Working Group'​s statement that investors believe that money market funds are '​risk-​free cash equivalents' (​p. 19). On the contrary, NAST believes that investors realize that money market funds have an inherent risk, albeit a small one. Furthermore, the Working Group itself states that moving to a floating NAV '​might motivate investors to shift assets away from MMFs to ... unregulated cash-​management vehicles' (​p. 19). This latter, we submit, would not be beneficial in any way. For these several reasons, the National Association of State Treasurers hereby goes on record as opposing a floating NAV for money market funds."

In another letter, Anthony Carfang, Partner at Treasury Strategies, writes to the SEC'​s Mary Shapiro, "Federal Reserve Chairman Bernanke, in a letter to me which I have enclosed, suggested that I share with you Treasury Strategies' concerns regarding a pending proposal by Moody'​s Investor Services that would rate money market funds based on an assessment of a fund sponsor'​s ability and willingness to support a financially stressed fund. Chairman Bernanke indicated that he too is concerned about Moody'​s proposal. Chairman Bernanke stated that the President'​s Working Group on Financial Markets, of which he and you are members, has recognized that discretionary financial support from sponsoring institutions raises a number of '​important policy issues.'" See also, Bloomberg'​s "​Bernanke Backs Moody'​s Critic in Debate Over Money Fund Ratings".

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Yesterday, the Federal Deposit Insurance Corporation released its latest "FDIC Quarterly, which "is published by the Division of Insurance and Research of the Federal Deposit Insurance Corporation and contains a comprehensive summary of the most current financial results for the banking industry." The latest publication contains a section on the "Temporary Liquidity Guarantee Program," which discusses the extension of the Transaction Account Guarantee program and unlimited FDIC insurance on non-​interest bearing transaction accounts. These dramatic temporary expansions in FDIC insurance are of course of interest to money market mutual funds, so we excerpt some of the highlights below.

The Quarterly says under "FDIC Responds to Market Disruptions with TLGP," "The FDIC Board approved the Temporary Liquidity Guarantee Program (​TLGP) on October 13, 2008, as major disruptions in credit markets blocked access to liquidity for financial institutions. The TLGP improved access to liquidity through two programs: the Transaction Account Guarantee Program (​TAGP), which fully guarantees noninterest-​bearing transaction deposit accounts above $​250,​000, regardless of dollar amount; and the Debt Guarantee Program (​DGP), which guarantees eligible senior unsecured debt issued by eligible institutions. All insured depository institutions were eligible to participate in the TAGP. Institutions eligible to participate in the DGP were insured depository institutions, U.​S. bank holding companies, certain U.​S. savings and loan holding companies, and other affiliates of insured depository institutions that the FDIC designated as eligible entities."

The section "FDIC Extends Guarantee Programs," explains, "Although financial markets improved significantly in the first half of 2009, portions of the industry were still affected by the recent economic turmoil. To facilitate the orderly phase-​out of the TLGP, and to continue access to FDIC guarantees where they were needed, the FDIC Board extended both the DGP and TAGP. On March 17, 2009, the Board of Directors of the FDIC voted to extend the deadline for issuance of guaranteed debt from June 30, 2009, to October 31, 2009, and extended the expiration date of the guarantee to the earlier of maturity of the debt or December 31, 2012, from June 30, 2012. The FDIC imposed a surcharge on debt issued with a maturity of one year or more beginning in second quarter 2009. The Board adopted a final rule on October 20, 2009, that allowed the DGP to expire on October 31, 2009."

It continues, "A final rule extending the TAGP six months, to June 30, 2010, was adopted on August 26, 2009. Entities participating in the TAGP had the opportunity to opt out of the extended program. Depository institutions that remained in the extended program were subject to increased fees that were adjusted to reflect the institution'​s risk. On June 22, 2010, the FDIC adopted a final rule extending the TAGP for another six months, through December 31, 2010. The final rule is almost identical to an interim rule adopted on April 13. Under the rule, the FDIC could extend the program for an additional 12 months without further rulemaking."

Under "Noninterest-​Bearing Transaction Accounts Fully Insured under Dodd-​Frank Reform Bill," the FDIC writes, "According to an amendment to the Dodd-​Frank Wall Street Reform and Consumer Protection Act, noninterest-​bearing transaction accounts at all FDIC-​insured institutions will be fully insured for two years. This amendment takes effect on December 31, 2010. Coverage of noninterest-​bearing transaction accounts is separate from the regular insurance limit of $​250,​000. Assessments for noninterest-​bearing transaction accounts will be included in the regular assessments for insured institutions."

The FDIC Quarterly also says, "A Majority of Eligible Entities Have Chosen to Participate in the TLGP." It explains, "About 74 percent of FDIC-​insured institutions opted in to the TAGP extension through December 31, 2010. More than half of all eligible entities elected to opt in to the DGP. Lists of institutions that opted out of the guarantee programs are posted at http://​www.​fdic.​gov/​regulations/​resources/​TLGP/​optout.​html."

Finally, the report says under, "$​107 Billion in Transaction Accounts over $​250,​000 Guaranteed," "According to third quarter 2010 Call and Thrift Financial Reports, insured institutions reported 190,​817 noninterest-​bearing transaction accounts over $​250,​000, fewer than one-​third the number of accounts reported at year-​end 2009. These deposit accounts totaled $​155 billion, of which $​107 billion was guaranteed under the TAGP. More than 5,​100 FDIC-​insured institutions reported noninterest-​bearing transaction accounts over $​250,​000 in value."

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Crane Data'​s flagship Money Fund Intelligence newsletter recently sent out a Subscriber Survey entitled "​Regulatory Reforms and the 2011 Outlook" in an attempt to gauge money fund providers' and investors' preferences and thoughts on future money fund regulations and changes. We now invite website visitors to participate in the survey too at: http://​www.​zoomerang.​com/​Survey/​WEB22BN3WKTR3A. We review the questions below, and we will release our results in the January issue of Money Fund Intelligence and later on www.​cranedata.​com.

The Crane Data Survey first asks, "​1. This question is in regard to the U.​S. Treasury'​s long-​awaited "Report of the President'​​s Working Group on Financial Markets: Money Market Fund Reform Options" paper, which details "a number of options for reforms related to money market funds." Which of the options do you think is the best alternative for money market mutual fund regulation? a. Floating net asset values; b. Private emergency liquidity facilities for MMFs; c. Mandatory redemptions in kind; d. Insurance for MMFs; e. A two-​​tier system of MMFs with enhanced protection for stable NAV funds; f. A two-​​tier system of MMFs with stable NAV MMFs reserved for retail investors; g. Regulating stable NAV MMFs as special purpose banks; h. Enhanced constraints on unregulated MMF substitutes; i. Other, please specify."

The survey then asked, "How would you rank these options for Money Market Fund Regulatory Reform (​from 1 to 10 with 10 being the highest)?" It then asked, "Which of these options do you think would do the most harm? (​The choices were: Floating net asset values, Private emergency liquidity facilities for MMFs, Mandatory redemptions in kind, Insurance for MMFs, A two-​​tier system of MMFs with enhanced protection for stable NAV funds, A two-​​tier system of MMFs with stable NAV MMFs reserved for retail investors, Regulating stable NAV MMFs as special purpose banks, Enhanced constraints on unregulated MMF substitutes, and Other, please specify."

We also asked, "On a scale of 1 to 10 (​highest), how important is the $​1.​00 stable value to money market mutual funds? The survey then asked respondents, "What is the most important issue facing money market funds today?" The choices included: Regulatory changes; Consolidation; Ultra-​low interest rates; Rising rates; Competition from banks or new products; and, Other, please specify.

The MFI survey then asked, "What is your outlook for the future of money market mutual funds?" Possible responses included: Very bearish; Bearish; Neutral; Bullish; and, Very Bullish. We also asked, "How much do you expect money fund assets to increase or decrease in 2011? Options included: Decrease by over 20%; Decrease by 10-​20%; Decrease by 0-​10%; Little or no change; Increase by 0-​10%; Increase by 10-​20%; and, Increase by over 20%.

Finally, we asked respondents, "What is your title or job function? Options included: Money fund portfolio manager, analyst or trader; Money fund sales or marketing; Money fund business development or board; Money market security issuer or dealer; Money market fund investors; Money fund service provider; Money fund rater or regulator; and, Other, please specify. Two demographic questions: "What is your name, title and e-​mail address?" and "Are you interested in seeing Crane Data collect or cover any information or news that it'​s not currently tracking?" were optional.

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We mentioned a recent "Fitch Default Study" in our "Link of the Day" last Thursday, but we only excerpted a couple of sentences. Today, we highlight some more sections from the Summary of the recent study. The Fitch paper, which "offers insight into the rating migration and default experience of Fitch rated ... short-​term debt issuers over the past two decade," says, "As with Fitch'​s long-​term issuer ratings, Fitch'​s global corporate short-​term issuer ratings or issuer default ratings (​IDRs) have exhibited a strong ability to differentiate default risk."

It explains, "Defaults have been infrequent at the very top of the rating scale, at the '​F1+' or '​F1' levels, and have also been modest further down the rating spectrum, with most occurring during economic recessions and affecting the speculative grade categories of '​B' or '​C'. The average 12-​month default rate on Fitch'​s '​F1+' ratings since 1990 was 0.​06%, compared with 0.​07% for '​F1' ratings, and 0.​10% and 0.​42% for the '​F2' and '​F3' rating categories, respectively."

Fitch also says, "Of the 54 Fitch-​rated short-​term corporate IDR defaults since 1990, 33 occurred in 2008−​2009 and 13 in 2001−​2002. Nearly 70% of these carried speculative grade ratings at the beginning of the year prior to default. Most years observed had no short-​term corporate IDR defaults. Further, few issuers had commercial paper (​CP) outstanding at the time of default.... Fitch recorded the lowest default rates over average 30-​day horizons for the period spanning 1990−​2009 with 60-​day, 90-​day, 180-​day, and 270-​day periods showing steady (​albeit moderate) increases in the frequency of default at each consecutive rating level."

Finally, the study adds, "The deep recession that followed Lehman'​s filing further hurt credit quality, sending the downgrade rate on long-​term corporate IDRs to a new high of 26.​7%. Similarly, the downgrade rate on corporate short-​term IDRs hit a high of 13.​3% in 2009, above 2008'​s similarly bleak 9.​2% rate and above the previous highs of 8.​1% and 7.​8% recorded in 2001 and 2002, respectively. Across the smaller universe of Fitch-​rated global SF short-​term securities, there have been few defaults historically. The five defaults in fact all occurred in the two year period of 2007−​2008 and emanated from the market value CDO and structured investment vehicle (​SIV) sectors. All five defaults however carried F1+ ratings either a year prior to default or at issuance. On an average 12-​month basis, the vast majority of Fitch rated SF short-​term securities either carried the same rating year over year, or matured with full payment."

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The Association of Financial Professionals, which represents corporate treasurers, recently posted an article entitled, "AFP Joins Coalition Opposing a Floating NAV for Money Market Funds. The piece says, "AFP is joining a broad-​based corporate effort to protect the ability of money market funds to operate with a stable $​1.​00 net asset value (​NAV). In a forthcoming comment letter to the Securities and Exchange Commission (​SEC), AFP will repeat its opposition to proposals that could undermine the usefulness of money market funds by requiring them to use a floating NAV."

"American business will lose one its most important sources of short-​term funding if money market funds are forced to abandon their stable per-​share value," reads the letter. AFP says, "​The comment letter will be signed by AFP along with the U.​S. Chamber of Commerce, Financial Executives International (​FEI), and the National Association of Corporate Treasurers. All four groups are encouraging their members to join in this effort by signing the letter as individual companies."

The piece continues, "The letter will be filed in response to the SEC'​s request for comments on an October report, The President'​s Working Group Report on Money Market Reform Options. The President'​s Working Group (​PWG) report suggests that money market mutual funds are susceptible to runs, which could contribute to systemic risks to the financial system. It then weighs the pros and cons of seven possible rule changes that the SEC could adopt. Three of those changes would require money market funds to use a floating NAV."

It explains, "Corporate finance professionals depend on money market funds as key instruments for cash management and short-​term investing. The stable $​1.​00 NAV provides key accounting and tax benefits for cash managers, and is required by many companies' treasury policies. Forcing these funds to adopt a floating NAV would gravely harm their usefulness and drive away investors. Shrinking money market funds would harm corporate financing in turn, as these funds purchase approximately one-​third of corporate commercial paper."

AFP also says, "Given the financial upheaval that such changes would likely create, the notion of floating NAVs has been widely opposed. In July, AFP and other key corporate finance organizations registered their opposition to these changes in a joint letter sent to Treasury Secretary Timothy F. Geithner and SEC Chairman Mary L. Schapiro. Now, corporate finance professionals must speak out again in the SEC'​s process."

Finally, the article adds, "Businesses are not alone in this effort. Investors, public utilities, state and local governments, and consumer groups have all urged regulators to preserve stable NAV money market funds. The SEC'​s deadline for public comments on the PWG report is January 10, 2011. If your company would like to sign onto a joint letter with the other companies as the signatories, please contact AFP'​s Director of Government Relations & Public Policy Jeanine Arnett at jarnett@​AFPonline.​org to have your company'​s name added to the list. AFP will also be submitting official comments outlining our specific positions on the report before the January deadline."

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Note: The following is excerted from the article "Sauter: Don'​t Confuse Liquidity With Credit," which appeared in our most recent Money Fund Intelligence newsletter.... We spoke this month with Vanguard Managing Director & Chief Investment Officer Gus Sauter, who discusses the recent release of information from the Federal Reserve on support programs for the money market. He also comments on the Liquidity Exchange Bank and on the future of money funds in general.

We ask, "You'​ve had some issues over recent reporting and wanted to clarify some things. What are your concerns?" Sauter tells MFI, "With the release of [​info on] the Fed Liquidity Programs, a lot of commentary is confusing a liquidity issue with a credit issue. A report might start describing that these liquidity facilities were put in place to alleviate some of the problems with liquidity in the marketplace, and then switch to a reference about credit issues. In reality, the liquidity facilities ... were not designed to enhance credit. They were only intended to break up the logjam in the marketplace.... I believe that the changes made to rule 2a-​7 have already largely addressed those concerns -- the liquidity requirements of 10% in one day and 30% in a week. I think those are positive changes and really address the issues that confronted money funds two years ago."

MFI then asks, "You see these really big numbers. How much was really at risk? He answers, "In fact, none of it was at risk. It turns out the Fed is not allowed to take credit risk. They were really only allowed to provide liquidity to the marketplace.... A lot of the commentary says, '​Well, the Fed bailed out money market funds.' [​But] they were actually working to get the markets moving again. The markets were completely frozen.... They were just trying to get things moving again, and I think they were very effective in doing that.... So it wasn'​t a bailout of money market funds. It was really just the facilitation of market liquidity.... All the money was repaid with interest to the Federal Reserve," he adds.

We also ask, "In your FSOC comment letter, you point out that the banks should be to blame for the problems. Is this true? Sauter says, "When the banks pulled the credit availability, it created gridlock. Dealers were afraid to put money at risk when they were uncertain about their short-​term financing ability.... That'​s when the Fed stepped and provided financing to the marketplace. Then, things started to roll again. I think it was an important move by the Federal Reserve and I think it was very effective. It didn'​t cost the taxpayers any money. It certainly was a tumultuous time. But the negative impact to money market funds was from a liquidity crisis, not a credit crisis. That'​s the important thing that a lot of people are forgetting."

Next, MFI asks, "Can you update us on the Liquidity Exchange Bank concept? Sauter responds, "I think it'​s a viable proposal. Some people are concerned that in the early days ... it'​s not going to have much funding. So in the initial stages, it'​s really not going to be able to provide perhaps enough liquidity to break up a freeze like we had a couple of years ago. I think that'​s true in the short run. But I think over time it will grow to sufficient size to provide appropriate liquidity. So I think it'​s an effective proposal that helps to ensure liquidity. Not only do you have the changes to rule 2a-​7, which requires more immediately liquid investments, but I think the Liquidity Exchange Bank, once it achieves critical mass, would also provide appropriate liquidity to the marketplace."

"Now the LEB would also not be able to take credit risk. So it'​s also not designed to alleviate credit problems in a money market fund and it should not be designed for that. The money market funds themselves should be managed in a prudent fashion as required by 2a-​7 so they'​re not exposed to undue credit risk. But if the fixed-​income marketplace, the money market marketplace, is not functioning correctly and liquidity dries up, that'​s when it steps in. That'​s where we do need that type of facility," he says.

MFI asks, "Q: Where does that process stand?" Sauter tells us, "The President'​s Working Group came out balanced in its view of the Liquidity Exchange Bank. We'​re in a comment period now and waiting for the SEC to analyze the comments before any decisions will be made.... I don'​t know how to handicap the likelihood that it will be a provision. But I do believe it would be a nice enhancement to the changes already made."

Finally, we ask, "Q: How important are money funds to Vanguard, to the economy and to investors? Are you concerned about the future? He answers, "I think money funds are extremely important to both the investing public and businesses.... They provide a liquid investment option that is very important to investors. At the same time, money funds provide relatively cheap short term financing to businesses and the public sector.... Without the existence of money market funds you'​d see corporate financing costs at much higher levels. So you have both the borrowers and the lenders benefiting quite significantly from the existence of money funds."

Finally, Sauter says, "We do worry that if money market funds are changed in a significant fashion, specifically if the NAV were allowed to float, that investors would view them very differently. They ... would not want to keep transactional balances there. Likely that would lead to a very different role for money market funds in the future.... Writing checks on a money market fund that has a floating NAV could be somewhat of a tax nightmare at the end of the year. It risks upsetting the balance between the desire for a stable, liquid investment by investors and low cost short-​term financing by corporations.... [​But] I still have confidence that the changes already made to 2a-​7, combined with a Liquidity Exchange Bank, will lead to money funds being even bigger and better 10 years from now."

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A press release entitled, "Tradeweb Launches Electronic Market for U.​S. Certificates of Deposit" announces, "Tradeweb, a leading global provider of fixed income and derivatives markets, today announced the launch of a new electronic market for U.​S. Certificates of Deposit (​CDs) on the Tradeweb Money Markets platform. The Tradeweb Money Markets platform is the only electronic marketplace that provides executable commingled, real-​time pricing of CDs delivered directly from leading dealers on a single screen."

The release explains, "The Tradeweb CD market offers a host of key advantages to institutional clients, including access to commingled indicative pricing for CDs, ranging in maturity from overnight to 13 months and the ability to request live, executable bids from up to five dealers at a time. Customized trade tickets provide quick and convenient access to primary and secondary offerings across a broad range of maturities through a flexible trade ticket screen designed to improve workflow. Trades are processed efficiently, reducing cost and operational risk, by incorporating pre- and post-​trade processing during systems integration."

Jon Williams, Managing Director and Head of U.​S. Markets at Tradeweb, comments, "We are pleased to step forward in broadening the Tradeweb Money Market offering with the launch of our new electronic platform for U.​S. CDs. As the fixed income markets continue evolving to improve transparency, execution speed and risk management, Tradeweb remains committed to providing flexible solutions to help increase transparency, liquidity and trade efficiency for our customers."

The press release adds, "The comprehensive trading solution also supplies traders with several new tools and data, including: Improved Issuer Lists and Filters to sort offerings and specific names; A Maturity Monitor to track all money market positions on a given date or range of dates; Real-​Time CD Rates with accurate CD composite prices, listed by rating and maturity; Quick Ticketing to enter trades by security details and CUSIP; and, Enhanced CD Charting of the yield curve to gauge the market and specific offerings."

Finally, the release says, "The Tradeweb Money Markets platform was launched in 2001 as an electronic marketplace for U.​S. commercial paper, followed by trading for agency discount notes in 2002. Since then, more than USD $​59 trillion in commercial paper and $​17.​5 trillion in agency discount notes have been executed on Tradeweb and the money markets platform has grown to offer a comprehensive trading solution for short agency coupons, treasury bills, tri-​party repos, commercial paper, agency discount notes and U.​S. certificates of deposit."

Certificates of Deposit represent the largest holding of Prime Institutional and Prime Retail money market funds at 27 and 25 percent, respectively, as of Nov. 30, according to the most recent Money Fund Intelligence XLS. (​This is followed by Repo, with 20 and 16 percent, respectively, and CP, with 19 and 21 percent.)

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Crane Data, which has tracked money market mutual funds and published its flagship Money Fund Intelligence newsletter since its launch in May 2006, is preparing to host its second money market mutual fund conference event, Crane'​s Money Fund University. In 2009, Crane Data entered the conference business with the introduction of Crane'​s Money Fund Symposium, which attracted more than 330 money market professionals to Boston in its second year this past summer. Our new Money Fund University, an affordable and comprehensive two day "​basic training" course on money market mutual funds will take place on January 13-​14, 2011, at The Westin Jersey City Newport.

Money Fund University will cover the history of money funds, interest rates, Rule 2a-​7, ratings, rankings, money market instruments such as commercial paper and repo, and portfolio construction and credit analysis. The agenda includes: "The History of Money Market Mutual Funds with Crane Data'​s Peter Crane and ICI'​s Sean Collins; Interest Rate Basics & Money Market Math with Bank of America Merrill Lynch'​s Brian Smedley and Columbia University'​s Phil Giles; The Federal Reserve & Money Markets with Wrightson ICAP'​s Lou Crandall and Barclays Capital'​s Joe Abate; Money Fund Regulations: Rule 2a-​7 Basics with Jenkins McLaughlin & Hunt LLP'​s John Hunt and Reed Smith'​s Stephen Keen. Money Fund Ratings & Surveillance by Fitch Ratings' Viktoria Baklanova and Standard & Poor'​s Joel Friedman; Money Fund Performance & Rankings by Peter Crane; and Crisis Review, Support & Reforms in MMFs by The Federal Reserve of Boston'​s Steffanie Brady.

Day two of the event includes the sessions: Instruments of the Money Markets with J.​P. Morgan Securities Alex Roever; Instruments: Commercial Paper & ABCP with Citi Global Markets' Rob Crowe and Credit Suisse'​s Stephanie Gentile; Instruments: CDs, TDs & Bank Debt with Wells Fargo Securities' Garret Sloan and Arrowhead Research'​s Barry Weiss; Treasuries, Govt Agencies & Repo with G.​X. Clarke'​s Sal Ursida and Jefferies & Co. Joe Tarditi; Repurchase Agreements with Alex Roever and J.​P. Morgan Securities' Ellie Boldenow; Tax-​Exempt Securities, VRDNs, TOBs & Muni Bonds with Dreyfus' Colleen Meehan and BofA Funds' Susan DuShock; Portfolio Construction Strategies with Western Asset'​s Martin Hanley and Joseph Tully; Credit Analysis & Approved Lists with Dreyfus' Louis Geser and Fidelity'​s Jacob Weinstein; and Hot Topics: FDIC, Portals, Offshore with Promontory Interfinancial Mark Brooks, State Street'​s Greg Fortuna and UBS'​s Tom Cameron.

Registration for Crane'​s Money Fund University is $​600. Exhibit space is $​2,​000 and sponsorship opportunities are $​3K, $​4.​5K, and $​5K. A small block of rooms have been reserved at the Westin Jersey City. The conference negotiate rate of $​169 plus tax (​14% currently) is available only through this Thursday, December 16th. For booking information click here. The Westin Jersey City Newport is located minutes from Newark Liberty International Airport, just west of Wall Street and Manhattan'​s World Financial Center; Greenwich Village; Union Square; Midtown Manhattan, and Times Square. The hotel is just one block from the Pavonia/​Newport PATH station and immediately adjacent to the 1.​2-​million-​square-​foot Newport Centre Mall.

Also, the preliminary agenda is now live for Crane'​s Money Fund Symposium, which will be held June 22-​24, 2011, at The Philadelphia Marriott (​Downtown). Registration is $​750 and sponsorships are available. E-​mail Pete to request a full brochure to MFU or MFS.

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Sunday'​s Financial Times contains a story quoting ICI'​s Paul Stevens on the future of money funds. (​It'​s unclear whether this is a new interview or is based on previous comments.) The FT article, entitled, "Future of money funds in question," says, "Money market funds are big business for fund managers in the US. More to the point, they are an intrinsic part of the funding model for municipalities and corporations, as became clear when money markets seized up in the financial crisis. But their future is in doubt as regulators consider whether they should be allowed to continue to operate as they have in the past."

It continues, Paul Stevens, president and chief executive of the Investment Company Institute, says his organisation has been lobbying for some time against some of the ideas put forward that threaten to destroy the basic model of money market funds -- in particular the stable net asset value of $​1 per share. He is concerned that loose talk about the 'shadow banking system' suggests there is something sinister about shadow banks, '​and they should be regulated like banks to make sure they pose no risks.'"

FT explains, This is illogical, given that it was the non-​shadow banks that posed big risks, says Mr Stevens. Moreover, it suggests money market funds are not regulated, which is not the case. Indeed, '​regulation has been substantially increased since 2008,' with rules laying down explicit liquidity standards and shortened maturity requirements, among other things. He acknowledges the extent to which money market funds required support from their parent groups during the crisis to prevent them '​breaking the buck', as having to let the price fall below $​1 per share is known."

The article says, "Mr Stevens says money market funds ran into problems '​because the banks stopped trusting each other', which suggests the problem lies as much in the banking system as with the shadow banks.... Whether the money would stay put if some of the reforms under consideration are implemented is a big question."

It adds, "Reform options are discussed in a report by the President'​s Working Group on Financial Markets, published in October. They include moving to floating rather than stable net asset values; private emergency liquidity facilities; insurance; regulating funds as special purpose banks; and a two-​tier system which either offers enhanced protection for stable NAV funds, or restricts access to such funds to retail investors, on the basis that the 2008 run on funds was mainly due to redemptions by institutional investors."

Finally, the piece says Stevens "remains optimistic about the eventual outcome. It quotes him, "​As long as issuers have a need to finance themselves on a short-​term basis, the market will respond. The question is whether the vehicle will be permitted to survive. I think the answer will be yes, but we will go through a period where we are still considering what needs to be done to address some of the risks."

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The Federal Reserve'​s latest quarterly "Flow of Funds Accounts of the United States - Z.​1" shows money fund assets flat in the third quarter of 2010, and shows a continued shift away from Treasuries and Agencies and towards repo and time deposits. The Flow of Funds contains two main tables related to money market funds, including L. 206 "Money Market Mutual Fund Shares," which shows investor types in money funds, and L.​121 "Money Market Mutual Funds," which shows investments held by money funds. The most recent Z.​1 report continues to show that households, funding corporations and nonfinancial corporate businesses remain the dominant categories of money fund shareholders, and flows from all of these major sectors were flat in Q3.

The household sector remains by far the largest holder of money fund shares with $​1.​13 trillion, or 41.​0% of the $​2.​746 trillion tracked by the Fed in Q3. Households reduced their money fund holdings by a mere $​14 billion in the second quarter, though they'​ve reduced holdings by $​232 billion, or 17.​1%, over the 1-​year through Sept. 30, 2010. Overall money fund assets declined by $​617 billion, or 18.​3%, over the same 12 months.

Funding corporations, defined by the Fed as "​funding subsidiaries, nonbank financial holding companies, [​and] custodial accounts for reinvested collateral of securities lending operations," remain the second largest holder of money fund shares with $​708 billion, or 25.​8% of assets. This is unchanged in the latest quarter but down $​236 billion, or 25.​0%, in the latest year. Funding corporations have shrunk their money fund balances from a high of $​1.​071 trillion at year-​end 2008, a decline of $​363 billion, or 33.​9%. (Households have shrunk balances by $​446 billion, or 28.​4% during this same period.) Nonfinancial corporate businesses, rank third among money fund investors, according to the Fed'​s quarterly Z.​1 series, with $​533 billion, or 19.​4% of assets. Corporates actually increased their money fund holdings slightly in latest quarter.

The Fed'​s money fund holdings table shows "​Time and savings deposits" and "​Security RPs" (​repos) increasing by $​38 billion and $​30 billion, respectively in Q3. These two categories represent the largest holdings of money funds with $​470 billion, or 17.​1% of assets, and $​493 billion, or 17.​9% of assets, respectively. Agency and GSE backed securities, the third largest category at 15.​1%, and Treasury securities the sixth largest at 11.​3%, showed big declines, falling $​35 billion and $​41 billion, respectively. Open market paper (​CP) now ranks fourth among holdings with $​386 billion (​14.​0%), and Municipal securities now ranks fifth $​332 billion (​12.​1%) each.

Consulting firm Treasury Strategies put out a press release late yesterday on the data entitled, "Corporate Cash Increases As Economic Uncertainty Continues According to Treasury Strategies," which says, "The Federal Reserve today reported corporate cash balances spiked to $​1.​93 trillion - a 38% increase since the first quarter of 2009 – representing $​530 billion. This significant increase indicates companies are still accumulating cash rather than redeploying it."

Cathy Gregg, Partner of Treasury Strategies, comments, "​From our work with clients, as well as survey data collected this week, we see corporations have experienced very strong growth in cash flow from operations. Since total corporate cash continues to grow, these findings together tell us corporations are still not comfortable with fully redeploying added cash, partly due to an uncertain economic outlook."

Today'​s Wall Street Journal also writes "​Companies Cling to Cash, Coffers Swell to 51-​year high as Cautious Firms Put Off Investing in Growth". The article says, "Corporate America'​s cash pile has hit its highest level in half a century. Rather than pouring their money into building plants or hiring workers, nonfinancial companies in the U.​S. were sitting on $​1.​93 trillion in cash and other liquid assets at the end of September, up from $​1.​8 trillion at the end of June, the Federal Reserve said Thursday. Cash accounted for 7.​4% of the companies' total assets -- the largest share since 1959."

For more on the Fed'​s Flow of Funds, visit www.​federalreserve.​gov/​releases/​z1/​Current/ or e-​mail info@​cranedata.​us to request Crane Data'​s Excel files of the Fed'​s money fund tables.

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Wells Fargo Advantage Funds writes in its latest "Overview, Strategy, and Outlook" about concerns over Europe. The monthly "Money market overview" by Dave Sylvester says, "The growing credit crisis in Europe dominated the news in November. After going to the aid of Greece this past summer, European authorities found themselves fighting increasing concerns about sovereign and banking credits in other parts of the continent. This crisis in confidence culminated over the U.​S. Thanksgiving holiday weekend, when the European Union (​E.​U.) effected a plan to rescue Ireland from the turmoil that has surrounded its banking industry.... As events have unfolded, investors have perceived increased credit risk in all European sovereign credits but especially those in the peripheral countries."

Sylvester writes, "The question is: Should the concerns that were appropriate in the case of Greece and Ireland be extrapolated to other European countries? And, perhaps more important from a money fund portfolio perspective, why has concern about sovereign credit quality become an issue for bank credits? For some time now, a country'​s ability to support its banks, or '​sovereign lift,' has been part of market participants' evaluation of the credit quality of banks.... While widely decried, '​too big to fail' has actually been viewed as a positive credit attribute. In the current environment, however, some bank credits have actually become fundamentally stronger than the countries that are presumed to be in a position to support them.... While we do not at all dismiss the psychological impact of the continued pounding on this theme by major news outlets, we feel that there are fundamental factors suggesting that not all Europeans should be painted with the same broad brush."

The piece continues, "While funding pressures on European banks have increased, funding through the ECB remains a viable alternative. In 2008, swap lines between the U.​S. Federal Reserve (​the Fed) and the ECB allowed the banks to access U.​S. dollar funding through this facility and were a major factor in stabilizing the markets in that period. These swap lines, which were reinstated in May 2010 during what can now be seen as the initial phase of this episode, will remain in place until at least January 2011. In addition to providing deep pockets for the European banks to tap, the penalty rate should (​or may) serve as a cap on rates, ensuring that the banks' funding costs do not get out of hand."

It says, "​The ECB also seems to have room to furnish additional liquidity to its banks on its own. Based on the amount of collateral that is available at European banks, it is reasonable to conclude that the ECB could fund its banks for several years, assuming that they were willing to expand their balance sheets to the degree that the Fed and the Bank of England have done. Whether or not the ECB is comfortable with providing this level of liquidity, given its historical focus on limiting potential sources of inflation, is another question. In discussing the government bond purchase program, Mr. Trichet emphasized that, unlike the Fed, the ECB is not engaged in a quantitative easing program and has withdrawn liquidity from the system in amounts equal to its bond purchases in order to limit the risks of inflation. Still, should the situation escalate, the ECB has the capacity to address the problem."

Wells explains, "During the summer, the initial phase of this crisis in confidence was alleviated through the application of '​stress tests' to banks, similar to those performed in the U.​S. Although they were widely criticized at the time for their lack of rigor, the tests succeeded in convincing the markets that the European banks were fundamentally sound. European authorities envisioned conducting follow-​up tests by a newly created entity, the European Banking Authority (​EBA). However, that agency is not scheduled to begin operations until early 2011, and there are already signs of disagreement among the member states about the structure of the EBA and the nature of the tests. Hopes are that the EBA will get up and running sooner rather than later and that the stress tests might be completed before the now anticipated target of mid-​2011."

Finally, Sylvester writes, Early indications are that the stress tests might focus on liquidity, a new favorite of the banking regulators. We discussed the liquidity coverage ratio and the net stable funding ratio that were part of the Basel III accords in some detail in our September commentary. In short, both are designed to induce banks to favor longer-​term retail deposits over shorter-​term wholesale funding. This is all well and good, but whether or not market participants will be inclined to extend longer-​term credit in this environment depends on confidence being quickly restored. While we remain confident in the fundamental credit quality of the selected European banks that we have approved for purchase, we are cautious in terms of our use and continue to monitor developments closely.

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We learned of another recent Comment Letter from the Investment Company Institute from mutual fund news website ignites. The latest missive, entitled, "ICI Letter On CFTC Proposal Restricting Investments Of Customer Funds In Money Market Funds," involves lobbying the CFTC to alter its proposal to restrict money fund investments as collateral. It'​s written by ICI General Counsel Karrie McMillen and addressed to David Stawick, Secretary at the Commodity Futures Trading Commission and entitled, "Investment of Customer Funds (​RIN 3038-​AC15)." It says, "The Investment Company Institute appreciates the opportunity to comment on the Commodity Futures Trading Commission'​s proposed changes to Regulation 1.​25 under the Commodity Exchange Act."

ICI explains, "Regulation 1.​25 provides that a futures commission merchant (​FCM) or derivatives clearing organization holding customer segregated funds may invest those funds in certain '​permitted investments,' subject to specified requirements designed to minimize exposure to credit, liquidity, and market risks. Our comments focus on the proposed changes concerning the treatment of money market funds as a '​permitted investment' for these purposes. As discussed below, ICI strongly believes that money market funds continue to represent investments '​consistent with the objectives of preserving principal and maintaining liquidity,' as required by Regulation 1.​25. Indeed, recent enhancements to money market fund regulation make money market funds even more appropriate as '​permitted investments' for FCM or DCO customer funds."

The letter continues, "We further believe that the proposed new limitations on investments in money market funds under Regulation 1.​25 are arbitrary and unduly severe. The practical effects of these limitations would be to require FCMs and DCOs to manage the vast majority of a portfolio of permitted investments themselves, and potentially to expose customer funds to greater credit, liquidity and/​or price risk. We urge the Commission to reconsider the proposed limitations in light of the actual risks posed by money market funds as compared to the other '​permitted investments.'"

On "Background," the ICI says, "​Section 4d(​a)(​2) of the CEA limits the investment of customer segregated funds to obligations of the United States, obligations fully guaranteed as to principal and interest by the United States, and general obligations of any State or any political subdivision thereof. Regulation 1.​25 expands the list of permitted investments to include government sponsored enterprise securities, bank certificates of deposit, commercial paper, corporate notes, general obligations of a sovereign nation, and shares of money market funds. Except for money market funds, these additional permitted investments must also satisfy the certain credit rating requirements."

Finally, they explain, "The Commission now proposes to remove from the investments permitted by Regulation 1.​25. GSE securities not backed by the full faith and credit of the United States, corporate debt obligations not guaranteed by the FDIC, foreign sovereign debt, and in-​house transactions. The proposed reforms also would seek to promote greater diversification by limiting the customer funds invested in any one class of assets (​other than U.​S. government securities) and extending '​issuer-​based' concentration limits to money market funds and repurchase agreement counterparties. More specifically, with respect to money market funds, the Commission proposes to apply an asset-​based concentration limit of 10% of total assets held in segregation. The Commission also proposes to restrict investments in any family of money market funds to 2% of total assets held in segregation. Taken together, these proposed limits would be the most restrictive ones on any class of permitted investments."

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The December issue of Crane Data'​s Money Fund Intelligence was sent out to subscribers Tuesday morning, along with our November 30 performance statistics. The latest edition will contain articles entitled, "Record Low Yields and 2nd Worst Outflows in '​10," which discusses the year in review; "Davis Advisors' Creston King Talks Government Money Market Funds," which interviews a Government portfolio manager; and, "Sauter on Confusing Liquidity With Credit," which contains comments on Federal Reserve support programs and the Liquidity Exchange Bank.

MFI'​s lead story says, "Though the year is not yet finished, 2010 will no doubt set the record for the lowest yields in money funds' 40-​year history. It also saw the second largest annual asset outflow in both percentage and dollar terms. Finally, the past year will be remembered for major regulatory changes and for its shifting competitive landscape."

Our "Fund Profile" this month interviews Creston King, portfolio manager at Davis Selected Advisers, which manages the Davis Government Money Market Fund, which is offered to buyers of the Davis series of equity funds, and the Selected Daily Government Fund, which used for the company'​s no-​load fund series. Both money funds are 100% exclusively "​government."

We asked King, "Did Davis choose to have just Government funds because of safety concerns? Or were you just lucky?" He answers, "Yes, they choose to have them because of safety. Founder Shelby Davis used to call bonds '​certificates of confiscation.' We don'​t want to have anything risky.... The reason behind it is that we want our customers to take risk in the equity funds. We don'​t want them to take risk in the bond fund or money fund."

Finally, we also spoke this month with Vanguard Managing Director & Chief Investment Officer Gus Sauter, who discusses the recent release of information from the Federal Reserve on support programs for the money market. He also comments on the Liquidity Exchange Bank and on the future of money funds in general.

Sauter tells MFI, "With the release of [​info on] the Fed Liquidity Programs, a lot of commentary is confusing a liquidity issue with a credit issue. A report might start describing that these liquidity facilities were put in place to alleviate some of the problems with liquidity in the marketplace, and then switch to a reference about credit issues. In reality, the liquidity facilities did nothing to address credit issues. They were not designed to enhance credit. They were only intended to break up the logjam in the marketplace.... So, since it was a liquidity problem, I believe that the changes made to rule 2a-​7 have already largely addressed those concerns -- the liquidity requirements of 10% in one day and 30% in a week. I think those are positive changes and really address the issues that confronted money funds two years ago."

Note that subscribers should see the latest issue arrive around 11am this morning.

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The Federal Reserve Bank of New York recently released a Staff Report entitled, "The Tri-​Party Repo Market before the 2010 Reforms," written by Adam Copeland, Antoine Martin, and Michael Walker. The Abstract says, "This paper provides a descriptive and quantitative account of the tri-​party repo market before the reforms proposed in 2010 by the Task Force on Tri-​Party Repo Infrastructure (​Task Force 2010). The NY Fed'​s Task ​Force ​on ​Tri-​Party ​Repo ​Infrastructure - Payments Risk Committee was formed in September 2009 and issued its original report on May 17, 2010.

The new paper'​s Abstract continues, "​We provide an extensive description of the mechanics of this market. We also use data from July 2008 to early 2010 to document quantitative features of the market. We find that both the level of haircuts and the amount of funding were surprisingly stable in this market. The stability of the margins is in contrast to evidence from other repo markets. Perhaps surprisingly, the data reveal relatively few signs of stress in the market for dealers other than Lehman Brothers, on which we provide some evidence. This suggests that runs in the tri-​party repo market may occur precipitously, like traditional bank runs, rather than manifest themselves as large increases in margins."

The Introduction explains, "This paper aims to shed some light on the US tri-​party repo market, an important funding market that played a role in some of the key events associated with the recent financial crisis. The Task Force on Tri-​Party Repo Infrastructure (​Task Force 2010) notes that '​At several points during the financial crisis of 2007-​2009, the tri-​party repo market took on particular importance in relation to the failures and near-​failures of Countrywide Securities, Bear Stearns, and Lehman Brothers. The potential for the tri-​party repo market to cease functioning, with impacts to securities firms, money market mutual funds, major banks involved in payment and settlements globally, and even to the liquidity of the U.​S. Treasury and Agency securities, has been cited by policy makers as a key concern behind aggressive interventions to contain the financial crisis.'"

It continues, "[​W]​e describe in some detail the mechanics of this market and some of its vulnerabilities. We also use data collected by the Federal Reserve Bank of New York (​FRBNY) to document quantitative features of this market. Our data covers the period from July 2008 to the beginning of 2010. The tri-​party repo market is a large funding market in which dealers fund their portfolios of securities through repurchase agreements (​repos). The largest cash providers in this market are money market mutual funds and securities lenders that seek a short-​term investment for their available cash. Two tri-​party clearing banks, JPMorgan Chase and the Bank of New York Mellon, provide intermediation services to the dealers and the cash investors."

The authors comment, "The vulnerabilities of the tri-​party repo market are magnified by its size, the fact that the share of less liquid collateral was growing before the crisis, and the fact that the majority of funding was short term, usually overnight. The size of the market reached $​2.​8 trillion and the size of the largest portfolios financed by dealers exceeded $​400 billion at the peak of the market. The share of less liquid collateral approached 30 percent of the collateral funded in the market at the peak and has decreased to less than 20 percent in 2010."

Copeland, Martin and Walker conclude, "We find that both the level of haircuts and the amount of funding were surprisingly stable in this market during the period for which we have data, from July 2008 to early 2010. The stability of the margins is in contrast to evidence from other repo markets. Of course, this apparent stability did not prevent the tri-​party repo market from contributing to the problems experienced by Lehman Brothers, on which we provide some evidence. The available evidence suggests that runs in the tri-​party repo market may occur precipitously, more like traditional bank runs, rather than manifest themselves in the form of large increases in margins."

Finally, they say, "​The data shows quite stable relationships between cash investors and the dealers they perceive to be creditworthy. While the amount of funds provided by some large cash investors does fluctuate somewhat, dealers can generally count on the same set of counterparties providing a minimum amount of funding. In particular, we find few examples of interruptions in the relationship between a cash investor and a dealer. The total amount of collateral funded in the tri-​party repo market decreased between July 2008 and early 2010, but anecdotal evidence suggests this could be due, in large part, to dealers'​s desire to reduce their leverage. While the market may have been stressed, it appears that most dealers were able to maintain stable funding in the tri-​party repo market from July 2008 to early 2010.... It is a challenge to reconcile the apparent stability of the tri-​party repo market with the dramatic events related to the failure of Lehman Brothers, to which the tri-​party repo market seems to have contributed."

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Money fund assets decreased by $​3.​25 billion in the latest week to $​2.​810 trillion in the week ended December 1, according to the most recent weekly statistics from the Investment Company Institute. Though they have declined by $​483 billion, or 14.​7%, year-​to-​date in 2010 (​following a decline of $​547 billion, or 14.​0% in 2009), assets have stubbornly remained at or above the $​2.​8 trillion level for the entire second half of the year. Though down over $​1 trillion since their peak of $​3.​9 trillion in mid-​January 2009, money fund assets remain above their level in August 2007, when the Subprime Liquidity Crisis began, and they still remain over $​1 trillion higher than their levels exactly 10 years ago.

ICI'​s latest numbers show Institutional assets, which continue to represent approximately two-​thirds of all assets (​66.​7%), at $​1.​875 trillion and Retail assets at $​942.​2 billion. Institutional money funds, which lost almost all of their assets during the first quarter of the year, have declined by $​351 billion, or 15.​8%. Retail assets, which dropped a sharp 21.​2% in 2009, have declined by a more modest $​132 billion, or 12.​4% in 2010. Crane Data expects very modest outflows in the first half of 2011 and high single digit percentage outflows in the second half as pressure for rate hikes builds. (​We look for a decline of about $​200 billion, or 7%, in 2011, and modest inflows in 2012 as rates climb towards 1-​2%.)

As we mentioned Tuesday (​see "Bond Assets Approach Money Fund Levels; MMFs Add Repo In October"), though bond funds have added $​461 billion YTD in 2010 and now rival money funds in size (​at $​2.​668 trillion) for the first time ever, there are indications that the inflow party is ending. Bond funds have seen two straight weeks of outflows (​according to ICI'​s "​Long-​Term Mutual Fund Flows") and may be headed for their first decline in assets since December 2008.

Vanguard CIO Gus Sauter recently released a paper, "Vanguard'​s investment chief cautions bond investors," which says, "Bonds have been on a roll, with double-​digit returns posted by several fixed income categories this year. Such a winning streak may tempt you to think you'​ve got a free lunch: return with no risk. That'​s hardly the case. Vanguard believes bonds and bond funds can play a valuable role in nearly any investor'​s portfolio. At the same time, we also believe it'​s important to have a balanced perspective and keep your eyes open to risks."

Sauter comments, "​I'​m increasingly worried that people aren'​t aware of the risks in the bond market. We have very low interest rate levels. But at some point, the economy will strengthen and those interest rates will rebound. Investors who have pushed out further on the yield curve by investing in longer-​term bonds will then see a greater decline in the principal value of their investments. When you'​re seeking yield by moving into longer-​term bonds, you'​re exposing yourself to greater fluctuations in principal. Those fluctuations are likely to be negative at some point in the future, and they'​ll be negative by a greater magnitude for longer-​term bonds than for shorter-​term bonds."

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Yesterday, the Federal Reserve released "detailed information about transactions conducted to stabilize markets during the recent financial crisis." The Fed'​s statement says, "The Federal Reserve Board on Wednesday posted detailed information on its public website about more than 21,​000 individual credit and other transactions conducted to stabilize markets during the recent financial crisis, restore the flow of credit to American families and businesses, and support economic recovery and job creation in the aftermath of the crisis. Many of the transactions, conducted through a variety of broad-​based lending facilities, provided liquidity to financial institutions and markets through fully secured, mostly short-​term loans."

It continues, "​As financial conditions have improved, the need for the broad-​based facilities has dissipated, and most were closed earlier this year. The Federal Reserve followed sound risk-​management practices in administering all of these programs, incurred no credit losses on programs that have been wound down, and expects to incur no credit losses on the few remaining programs. These facilities were open to participants that met clearly outlined eligibility criteria; participation in them reflected the severe market disruptions during the financial crisis and generally did not reflect participants' financial weakness."

The statement adds, "The Federal Reserve is committed to transparency and has previously provided extensive aggregate information on its facilities in weekly and monthly reports. As provided by the Dodd-​Frank Wall Street Reform and Consumer Protection Act of 2010, transaction-​level details now are posted from December 1, 2007, to July 21, 2010, in the following programs: Asset-​Backed Commercial Paper Money Market Mutual Fund Liquidity Facility (​AMLF), Term Asset-​Backed Securities Loan Facility (​TALF), Primary Dealer Credit Facility (​PDCF), Commercial Paper Funding Facility (​CPFF).... The data made available Wednesday can be downloaded in multiple formats, including Excel, at www.​federalreserve.​gov/​newsevents/​reform_transaction.​htm."

Under, "Usage of Federal Reserve Credit and Liquidity Facilities," the Fed'​s release comments, "This section of the website provides detailed information about the liquidity and credit programs and other monetary policy tools that the Federal Reserve used to respond to the financial crisis that emerged in the summer of 2007. These programs fall into three broad categories -- those aimed at addressing severe liquidity strains in key financial markets, those aimed at providing credit to troubled systemically important institutions, and those aimed at fostering economic recovery by lowering longer-​term interest rates."

It adds, "The emergency liquidity programs that the Federal Reserve set up provided secured and mostly short-​term loans. Over time, these programs helped to alleviate the strains and to restore normal functioning in a number of key financial markets, supporting the flow of credit to businesses and households. As financial markets stabilized, the Federal Reserve closed most of these programs. Indeed, many of the programs were intentionally priced to be unattractive to borrowers when markets are functioning normally and, as a result, wound down as market conditions improved. The programs achieved their intended purposes with no loss to taxpayers."

About its AMLF, the Fed explains, "Money market mutual funds (​MMMFs) are common investment vehicles that, in aggregate, hold trillions of dollars in funds on behalf of individuals, pension funds, municipalities, businesses, and others. During the financial crisis, MMMFs experienced significant withdrawals of funds by investors and were forced to meet the demand for withdrawals by selling assets in illiquid markets. The Asset-​Backed Commercial Paper Money Market Mutual Fund Liquidity Facility (​AMLF) was introduced to help MMMFs that held asset-​backed commercial paper (​ABCP) meet investors' demands for redemptions, and to foster liquidity in the ABCP market and money markets more generally."

It says, "The AMLF was designed to provide a market for ABCP that MMMFs sought to sell. Under the program, the Federal Reserve provided nonrecourse loans to U.​S. depository institutions, U.​S. bank holding companies, U.​S. broker-​dealer subsidiaries of such holding companies, and U.​S. branches and agencies of foreign banks. These institutions used the funding to purchase eligible ABCP from MMMFs. Borrowers under the AMLF, therefore, served as conduits in providing liquidity to MMMFs, and the MMMFs were the primary beneficiaries of the AMLF. AMLF loans were fully collateralized by the ABCP purchased by the AMLF borrower. The ABCP had to meet eligibility requirements outlined in the program'​s terms and conditions. Further, to help ensure that the AMLF was used for its intended purpose, the Federal Reserve later required that an MMMF had to experience material outflows before the ABCP that it sold would be eligible collateral for AMLF loans."

The Fed writes, "The AMLF was created by the Federal Reserve under the authority of Section 13(​3) of the Federal Reserve Act, which permitted the Board, in unusual and exigent circumstances, to authorize Reserve Banks to extend credit to individuals, partnerships, and corporations. The facility was administered by the Federal Reserve Bank of Boston, which was authorized to make AMLF loans to eligible borrowers in all 12 Federal Reserve Districts. The facility was announced on September 19, 2008, and was closed on February 1, 2010. All loans made under the facility were repaid in full, with interest, in accordance with the terms of the facility."

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Today'​s Wall Street Journal writes "​Some U.​S. Money Funds Exposed to European Banks". The article says, "Some of the largest U.​S. money-​market funds hold billions of dollars in securities issued by Spanish and Italian banks, highlighting the risk that further deterioration in Europe could have broad impact. Many European banks have long been dependent on investors for funding because their deposit base is too small relative to their loans outstanding. U.​S. money-​market funds have been a major source of that cash. Money-​market funds in the U.​S. hold about $​400 billion of their $​2.​8 trillion in assets in foreign banks, according to J.​P. Morgan."

The Journal piece says, "Among the major U.​S. funds, Fidelity Cash Reserves, the largest retail money fund, held $​4.​2 billion, or 3.​5% of its assets, in certificates of deposit issued by Spanish bank Banco Bilbao Vizcaya Argentaria SA, or BBVA, and Italian banks UniCredit SpA and Intesa Sanpaolo SpA as of Oct. 31. Schwab Cash Reserves, the third-​largest fund, had $​1.​5 billion in securities from Banco Santander SA, BBVA, UniCredit and Intesa. Western Asset Money Market Fund, owned by asset manager Legg Mason Inc., the ninth-​largest fund, holds $​848 million in Banco Santander, BBVA and Intesa. The banks remain highly rated by the major bond-​rating firms. Analysts said the bigger risks in Spain are smaller savings banks, not the big commercial firms."

The piece adds, "The money funds that hold their debt, meanwhile, remain in solid shape, said analysts. They hold short-​term commercial paper and certificates of deposit, among other assets, and the short maturities reduce the risk of default."

Legg Mason spokeswoman Mary Athridge comments, "We are comfortable with the position; it is relatively small, the maturities are short, we are comfortable with the creditworthiness of the institutions, and that is augmented by the fact that there are liquidity facilities available from the [​European Union] and [​European Central Bank]. We will continue to carefully monitor the situation." Fidelity spokesman Adam Banker told the Journal, "We can tell you that we are very comfortable with all of our funds holdings in foreign banks."

The article quotes Peter Crane, president of Crane Data LLC, a money-​market-​fund research firm, "The funds may be backing away from European banks, but it'​s not a real threat to money-​market investors in the U.​S.." The Journal says, "The problems at two large Irish banks in recent weeks and the subsequent bailout of Ireland'​s financial system have rekindled fears that European banks are in poor health. Investors have been wary of European banks for at least the past year because, like Lehman, they depend heavily on wholesale commercial borrowing.... Money-​market funds stopped buying securities issued by Irish banks in the past two to three months, Mr. Crane said."

Finally, the WSJ piece adds, "In the wake of the Reserve Primary Fund debacle, new money-​market rules were put in place to reduce systemic risk. Funds are now required to hold 30% of their assets in securities that mature in seven days or less. Regulators also placed limits on credit quality, to ensure that money-​fund managers hold only the most-​liquid assets. The new rules haven'​t been tested during a major global selloff, but analysts said they should help money funds weather the failure of a large institution much more easily than in 2008."

Note that the Journal article references last month'​s portfolio holdings, the majority of which have already matured. November 30 holdings won'​t be published until December 7th. Portfolio holdings of the largest money market funds are now available to subscribers of Crane Data'​s Money Fund Wisdom database query website. E-​mail Pete to request a look at the most recent holdings.

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