Fed Chairman Bernanke on Money Market Mutual Funds
November 19, 2008
Federal Reserve Chairman Ben Bernanke addressed the mutual fund money market industry in comments made before Congress on November 18, 2008. The huge amount of money withdrawn out of money funds since September has been an ongoing aggravation in the credit crisis. Bernanke and the Fed have already addressed investor fears regarding money funds with the federal guarantee program in which most mutual fund companies have opted to participate. Bernanke told the Committee on Financial Services in the U.S. House of Representatives in part:
"Normally, money market mutual funds are major lenders in the commercial paper markets. However, in mid-September, a large fund suffered losses and heavy redemptions, causing it to suspend further redemptions and then close. In the next few weeks, investors withdrew almost $500 billion from prime money market funds. The funds, concerned about their ability to meet further redemptions, began to reduce their purchases of commercial paper and limit the maturity of such paper to only overnight or other very short maturities. As a result, interest rate spreads paid by issuers on longer-maturity commercial paper widened significantly, and issuers were exposed to the costs and risks of having to roll over increasingly large amounts of paper each day.
The Federal Reserve has developed three programs to address these problems. The first allows money market mutual funds to sell asset-backed commercial paper to banking organizations, which are then permitted to borrow against the paper on a non-recourse basis from the Federal Reserve Bank of Boston. Usage of that facility peaked at around $150 billion. The facility contributed importantly to the ability of money funds to meet redemption pressures when they were most intense and remains available as a backstop should such pressures reemerge.
The second program involves the funding of a special-purpose vehicle that purchases highly rated commercial paper issued by financial and nonfinancial businesses at a term of three months. This facility has purchased about $250 billion of commercial paper, allowing many firms to extend significant amounts of funding into next year.
A third facility, expected to be operational next week, will provide a liquidity backstop directly to money market mutual funds. This facility is intended to give funds confidence to extend significantly the maturities of their investments and reduce over time the reliance of issuers on sales to the Federal Reserve's special-purpose vehicle. All of these programs, which were created under section 13(3) of the Federal Reserve Act, must be terminated when conditions in financial markets are determined by the Federal Reserve to no longer be unusual and exigent.
The primary objective of these and other actions we have taken is to stabilize credit markets and to improve the access to credit of businesses and households. There are some signs that credit markets, while still quite strained, are improving. Interbank short-term funding rates have fallen notably since mid-October, and we are seeing greater stability in money market mutual funds and in the commercial paper market. Interest rates on higher-rated bonds issued by corporations and municipalities have fallen somewhat, and bond issuance for these entities rose a bit in recent weeks. The ongoing capital injections under the TARP are continuing to bring stability to the banking system and have reduced some of the pressure on banks to deleverage, two critical first steps toward restarting flows of new credit. However, overall, credit conditions are still far from normal, with risk spreads remaining very elevated and banks reporting that they continued to tighten lending standards through October. There has been little or no bond issuance by lower-rated corporations or securitization of consumer loans in recent weeks.
To help address the tightness of credit, on November 12 the federal banking agencies issued a joint statement on meeting the needs of creditworthy borrowers. The statement took note of the recent strong policy actions designed to promote financial stability and improve banks' access to capital and funding. In light of those actions, which have increased the capacity of banks to lend, it is imperative that all banking organizations and their regulators work together to ensure that the needs of creditworthy borrowers are met in a manner consistent with safety and soundness. As capital adequacy is critical in determining a banking organization's ability and willingness to lend, the joint statement emphasizes the need for careful capital planning, including setting appropriate dividend policies. The statement also notes the agencies' expectation that banking organizations should work with existing borrowers to avoid preventable foreclosures, which can be costly to all involved--the borrower, the lender, and the communities in which they are located. Steps that should be taken in this area include ensuring adequate funding and staffing of mortgage servicing operations and adopting systematic, proactive, and streamlined mortgage loan modification protocols aimed at providing long-term sustainability for borrowers. Finally, the agencies expect banking organizations to conduct regular reviews of their management compensation policies to ensure that they encourage prudent lending and discourage excessive risk-taking."
