Alert September 23, 2008

A Summary of the Proposals from the Federal Government to Assist Money Market Funds

Last week, with one large money market fund “breaking a buck” and another electing to close and liquidate when faced with significant redemption requests, the Federal government proposed several measures designed to assist money market funds in maintaining a stable net asset value per share.  Many of these proposals are in preliminary stages, and the only publicly available information describing them is from press releases.  This article briefly summarizes those proposals.

Guarantee of Money Market Funds by the Treasury.  The U.S. Treasury has proposed generally to guarantee the $1 share price of a publicly offered, retail or institutional money market fund registered under the Investment Company Act of 1940 (the “1940 Act”) that complies with Rule 2a-7 under the 1940 Act if the net asset value per share of the money market fund falls below $1.  The guarantee would apply only (a) after the money market fund’s board elected to liquidate the fund and (b) if in the absence of the program, shareholders would receive less than $1 per share.  The maximum amount payable under the program is $50 billion, all of which would come from the Exchange Stabilization Fund (the “ESF”) established by the Gold Reserve Act of 1934.  The program would be closed after one year.

Other important features of the program, as currently proposed by the Treasury are:  money market funds are not compelled to participate in the program; those money market funds that do participate are required to pay a fee (which has not been determined); and only “non-government, non-agency” money market funds may participate (but it is not clear whether a fund may participate if it holds both corporate and government securities).  In addition, under the Treasury program, the guarantee would not be capped for any one investor, i.e., there would be no limit on the protection offered each fund investor comparable to the $100,000 per depositor limit that applies to FDIC-insured bank accounts.  To eliminate any incentive for investors to move their deposits out of bank accounts and into money market mutual funds, however, the guarantee would be limited to balances that existed as of the close of business on Friday, September 19, 2008.

The Treasury also issued Notice 2008-81, effective September 22, 2008, in which it announced that tax-exempt money market funds may participate in the program without violating Section 149(b) of the Internal Revenue Code of 1986.  Section 149(b) generally prohibits federal guarantees of tax-exempt bonds.  The Notice also states that Federal tax authorities will not assert that the program impairs a money market fund’s ability to designate exempt-interest dividends or a money market fund shareholder’s ability to treat those distributions as exempt from federal income tax.

The principal Treasury press releases relating to this program may be found here: http://www.treas.gov/press/releases/hp1147.htm and: http://www.treas.gov/press/releases/hp1151.htm.  A copy of Notice 2008-81 may be found here: http://www.irs.gov/pub/irs-drop/n-08-81.pdf.

Legislative Alternative to Treasury Guarantee Program.  On Monday, September 22, 2008, Senator Christopher Dodd (Dem., Connecticut), Chairman of the Senate Banking Committee, proposed an alternative to, among other things, the Treasury’s program to assist money market funds.  Under Senator Dodd’s proposal as it relates expressly to money market funds, the Treasury could use the ESF temporarily, but would be prohibited from using the ESF once legislation is passed for that purpose, and the Treasury would have to reimburse the ESF for any expenditure it caused the ESF to make to a money market fund under the program.  In addition, the Treasury would be permitted for 120 days to guarantee money market funds as a part of the program, and for up to a year from the date of enactment, if the Treasury certifies the need to Congress.  Senator Dodd’s proposal also would require that any guarantee provided to money market funds under the program may not exceed FDIC coverage amounts (with certain exceptions, $100,000 per depositor per financial institution, although it is not clear from the Senator’s proposal whether a financial institution, for the purpose of the program, is an individual money market fund or one or more money market funds managed or sponsored by the same investment manager).  Finally, under the Senator’s proposal, the Treasury must charge money market funds participating in the program fees at a rate equivalent to the rates that the FDIC charges federally insured banks.

A summary of Senator Dodd’s proposal, as well as a draft bill reflecting that proposal, may be found here: http://banking.senate.gov/public/index.cfm?Fuseaction=Articles.Detail&Article_id=0e1cd224-b6e7-446d-a8fb-e96c7ebc7f24.

FRB to Purchase Agency Debt.  On September 19, 2008, the Federal Reserve Bank of New York (the “FRB-NY”) announced that the Open Market Trading Desk will begin purchasing short-term debt obligations issued by the Federal National Mortgage Association (“FannieMae”), the Federal Home Loan Mortgage Corporation (“FreddieMac”), and the Federal Home Loan Banks.  As stated by the FRB-NY, “purchases … will be conducted with the Federal Reserve’s primary dealers through a series of competitive auctions via the [Open Market Trading] Desk’s FedTrade system.”  The goal of the program is to bring back liquidity into the agency market by reducing primary dealers’ holdings of those securities.  Although this buy-back program will not be limited to agency securities held by money market funds, money market funds that have significant positions in agency securities are intended beneficiaries.  The FRB states that the program is expected to expire on January 30, 2009.

The FRB’s press release relating to this program may be found here: http://www.newyorkfed.org/newsevents/news/markets/2008/rp080919.html.

FRB Lending Program to Help Finance the Purchase of Asset Backed Commercial Paper from Money Market Funds.  The FRB also announced on September 19, 2008 that it is instituting a new lending program that is intended, among other things, to assist money market funds in obtaining liquidity to meet redemptions by enabling them to sell some of their secured assets at amortized cost.  The lending facility will be administered for the FRB by the Federal Reserve Bank of Boston (the “FRB-Boston”).  Under the program, U.S. depository institutions and bank holding companies may borrow from a liquidity facility established by the FRB to purchase from any fund that qualifies as a money market fund under Rule 2a‑7 under the 1940 Act, eligible asset-backed commercial paper under certain conditions.  Any advance under the program is non-recourse to the FRB-Boston, and secured by the asset‑backed commercial paper purchased with the loan proceeds.  Among other things, only asset‑backed commercial paper that is a “First Tier Security,” as that term is defined under Rule 2a-7 (generally, the commercial paper must be rated by at least two nationally recognized statistical rating companies, at the time of pledge, in their highest short-term ratings categories), are eligible for purchase under the program.  The interest rate applicable to the loans will be equal to the primary credit rate in effect on the initiation date of the loan.  For eligible borrowers that are not depository institutions, advances remain outstanding for the remaining term of the asset‑backed commercial paper.  For eligible borrowers that are depository institutions, the advance and the maturity of the underlying pledged commercial paper may not exceed 120 days.

In addition, the FRB adopted interim regulatory exemptions for member banks from certain provisions of Sections 23A and 23B of the Federal Reserve Act and the FRB’s Regulation W.  These interim exemptions will increase the capacity of a member bank to purchase asset backed commercial paper from affiliated money market funds in connection with the new lending program. 

The FRB states that the program is expected to start immediately, and it is expected to expire on January 30, 2009, unless extended by the FRB.

The FRB’s press release relating to this program may be found here: http://www.federalreserve.gov/newsevents/press/monetary/20080919c.htm.

SEC Clarifies that Support for Money Market Funds Does Not Require On-Balance Sheet Reporting.  On September 17, 2008, the Office of the Chief Accountant of the SEC clarified that a financial institution’s support of a money market fund generally does not require the institution to present the money market fund on the institution’s balance sheet provided that the financial institution does not absorb the majority of the expected future risk associated with the fund’s assets.  Those risks may include interest rate, liquidity, credit and other relevant risks that are expected to impact the value of the money market fund’s assets.  The SEC staff, however, expects adequate disclosure of the nature of any support provided.

The SEC’s press release concerning the accounting treatment of bank support for money market funds may be found here: http://www.sec.gov/news/press/2008/2008-205.htm.