May 10, 2011 / 9:55 PM / 8 years ago

UPDATE 1-FDIC warns on moral hazard for money market funds

* SEC has already imposed money market reforms

* Council of regulators must weigh in on further reforms

* Industry opposes idea of floating NAV (Updates with details, background)

By Richard Leong and Rachelle Younglai

NEW YORK/WASHINGTON, May 10 (Reuters) - U.S. banking regulator Sheila Bair warned her fellow financial supervisors on Tuesday that a federal backstop for money market funds could induce careless corporate behavior because of a belief the government would always come to the rescue.

Bair, outgoing chairman of the Federal Deposit Insurance Corp, said regulators needed to be mindful of so-called moral hazard in creating a backstop for the $2.7 trillion industry.

During the financial crisis, the federal government was forced to backstop the market after the collapse of Lehman Brothers pushed the value of the Reserve Fund money market fund below $1 a share, wreaking havoc on the industry.

The Securities and Exchange Commission has already taken steps to tighten oversight of the money market funds. It now requires the funds to publicly disclose the net asset value, or value of each share of a money fund, on a 60-day lag basis.

The new Financial Stability Oversight Council, which was set up under the Dodd-Frank law to monitor risks to the financial system, has been tasked with considering more dramatic reforms.

Those include emergency liquidity facilities and changing the funds’ net asset value (NAV), which is currently fixed at about $1 per share, to a floating value.

A $1-per-share price has been the cornerstone for the money market fund industry. This practice has engendered the perception that money funds are only a tad riskier than bank accounts guaranteed by the government.

Supporters of the floating NAV concept have said changes in a fund’s share price gauge its riskiness.

The industry largely opposes the idea of a fluctuating NAV as expensive and unwanted by investors.

“A stable NAV is extremely important,” Kathryn Hewitt, treasurer of Harford County, Maryland, told council members. If that is removed, “my government won’t be in it,” she said.

At the same public meeting to discuss changes to the money market fund industry, Bank of England deputy governor of financial stability Paul Tucker said a floating NAV would “change the psychology of the investors.”

“It would take away implicit state support,” he said. (Additional reporting by Ross Kerber in Boston; Editing by Kenneth Barry)

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