January 12, 2011 / 5:29 PM / 9 years ago

UPDATE 1-Fed's Lacker backs floating value for money funds

* $1/shr price promotes risk taking, should end - Lacker

* Floating shr price only solution for funds - Lacker

* Govt should not expand safety net - Lacker

(Adds details from Lacker’s letter to SEC)

By Richard Leong

NEW YORK, Jan 12 (Reuters) - Money market fund share prices should float and abandon a $1 per share peg as it encourages risk-taking, Richmond Federal Reserve President Jeffrey Lacker said.

In a letter to the Securities and Exchange Commission, Lacker said he backed a proposal made last October by the President’s Working Group on Financial Markets to switch to a floating net asset value (NAV) as part of reforms to the money fund industry.

In the aftermath of the global credit crisis, the $2.8 trillion money market fund industry has opposed such a move due to the likelihood many investors would abandon money funds. See [ID:nN11130178]

But investor expectations the U.S. central bank would intervene in money market funds in the case of another financial crisis means their risk-taking “is being subsidized, (and) shareholders are likely receiving inappropriately high returns”, Lacker said.

The proposal for a change to floating NAV is “by far, the most attractive” among the proposed changes issued by the working group, Lacker said in the SEC letter dated Jan. 10.

A $1-per-share price principle has been the cornerstone for the money market fund industry, which began four decades ago. This practice has engendered the perception money funds are only a bit riskier than bank accounts guaranteed by the government.

Then in Sept. 2008, the collapse of Lehman Brothers in Sept. 2008 led to one of the oldest U.S. money funds whose shares fell below $1 or “broke the buck”. This watershed event during the global financial crisis resulted in the Federal Reserve and other central banks taking drastic steps to save the financial system.

The Fed implemented backstops in a bid to prevent runs in money funds. In an effort to shore up the safety of money market funds, SEC toughened last year requirements for funds to hold very liquid, short-dated investments.

These measures imposed last year have mitigated the problems with funds maintaining $1-a-share, but floating NAV is the “only certain solution,” Lacker said.

Other proposals like explicit government guarantees for money funds and the industry creating a special bank to deal with problem funds are better than the current situation.

Still “they needlessly expand the government safety net and thus are second best...to requiring floating NAVs,” he said.

Reporting by Richard Leong; Editing by Andrew Hay

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