July 19, 2012 / 7:48 PM / 7 years ago

New York Fed plan aims to stop runs on money funds

NEW YORK (Reuters) - Federal Reserve economists are pushing reforms that would protect against runs on U.S. money market mutual funds by introducing a ‘minimum balance at risk’ to dissuade investors from running at the first sign of trouble.

The minimum balance would make the financial system more fair, reduce systemic risk and protect smaller investors who can be left with losses if larger investors in their fund withdraw cash first, argues the staff report by the Federal Reserve Bank of New York.

The popular money market mutual funds are required to invest in low-risk securities, and had some $2.7 trillion in assets at the end of last year.

In 2008, the market’s vulnerabilities came to light when the big Reserve Primary Fund “broke the buck,” meaning its per-share value fell below $1 because of heavy losses on debt holdings in Lehman Brothers, which had collapsed a few days earlier.

The New York Fed’s plan comes as the U.S. Securities and Exchange Commission debates its own proposals including combining capital buffers and a withholding of redemption requests by investors, or alternatively a floating net asset value.

In a statement, New York Fed President William Dudley said he would “strongly endorse” the adoption of any proposal that is consistent with the basic idea discussed in the staff report released Thursday by his regional Fed bank.

“Further reform of money funds is essential for our nation’s financial stability,” said Dudley, whose Fed bank is Wall Street’s main regulator and is responsible for the U.S. central bank’s open market actions.

Dudley supports the SEC’s plan, a Fed official said.

The Fed proposal would require a “small fraction” of each fund investor’s recent balances to be demarcated to absorb losses if the fund is liquidated.

Redemptions of these minimum balances at risk would be delayed for 30 days, “creating a disincentive to redeem if the fund is likely to have losses,” said the 77-page paper co-authored by New York Fed economists and officials Patrick McCabe, Marco Cipriani, Michael Holscher and Antoine Martin.

Under the plan, small investors could be exempted from the minimum balance requirement.

Investors in money market mutual funds - which are not required to hold capital - are currently better off being among the first to run when there is trouble because they would get 100 cents on the dollar.

Last month, Boston Fed President Eric Rosengren floated the idea of expanding the bank “stress tests” to include the likely support these institutions would need to provide to the money market funds that they sponsor. (Editing by James Dalgleish)

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