Opinion: A Collateral Proposal

In practice, banks guarantee the credit quality of the Money Market Funds they sponsor. This guarantee should be reflected when computing their capital ratios.

Look for the opinion link!

Update, 2008-9-18: After Reserve Primary Fund broke the buck on September 16, there were some avowals of credit support from sponsors:

Bank of America Corp. and Federated Investors Inc. disclosed their most recent holdings and pledged to protect investors after the $3.45 trillion money-market fund industry was jolted by its first loss in 14 years.

As U.S. stocks fell 4.7 percent for the second time in three days, money-fund managers said yesterday they will commit capital to offset any investment losses they incur. They sought to calm investors after Reserve Primary, the nation’s oldest money fund, did what no competitor had done since 1994 — allow its net asset value to fall below $1 a share, or break the buck.

14 Responses to “Opinion: A Collateral Proposal”

  1. […] I certainly agree with the need for a continuous update of regulation – I have argued for increased capital requirements for loan committments (e.g., liquidity guarantees for SIVs) and more recently, for recognition of the credit risk on bank-sponsored Money Market Funds. And while it is indeed “child’s play for brilliant and motivated insiders to game such regulation”, it is also child’s play for a bored routiner at the regulator to update regulation. Remember: bank regulation does not need to be perfect. It only needs to be good enough. To date, I have seen no evidence that it hasn’t been good enough. […]

  2. […] But while letting the speculators speculate, we should ensure the core financial system is not put at risk; this may be accomplished simply by increasing the capital charges on banks’ exposures to shadow-banking. The capital charge for liquidity guarantees to SIVs does not appear to have been enough – double it! And, as I have argued, it appears that in practice, banks retain credit exposure to instruments held by their money market funds – they should be taking a capital charge for this exposure. […]

  3. […] sheet instruments were not charged against capital at a high enough rate (one example is money market funds, not just SIVs); concentration risk was not charged to capital (at least, not sufficiently) and big […]

  4. […] Today’s Globe and Mail contained an op-ed piece by Ian de Verteuil which is supportive, at least in principal, of the opinion piece I had published earlier this year A Collateral Proposal. […]

  5. […] I hadn’t been aware of this when I wrote my opinion piece A Collateral Proposal… […]

  6. […] It leads to another interesting thought … if banks are to be on the hook for short-term paper they sell to their retail clients, shouldn’t this be recognized as credit risk (in addition to operational risk) for capital calculation purposes? I’ve already advocated that their exposure to their branded MMFs be recognized. […]

  7. […] discussed this issue – a bit – in my essay A Collateral Proposal, but I’m still having some trouble understanding it. Money market funds invest in commercial […]

  8. […] Readers will remember my proposal to have banks consolidate their branded MMFs for capital purposes … I thought that was pretty radical, but I’m beginning to wonder if it’s enough. […]

  9. […] Readers will remember that I have called for bank-sponsored money market funds to be consolidated in their sponsors’ balance sheets for risk measurement […]

  10. […] Readers will recall my Collateral Proposal of last year: In practice, banks guarantee the credit quality of the Money Market Funds they […]

  11. […] funds as beneficiaries of non-contractual support. OSFI refuses to consider the question. I have repeatedly urged that money market funds be considered securitizations; another article on the topic is, by the way, […]

  12. […] Encouraging, but not consequential. If they want to get bank lines, they can get them now; this is merely a method whereby they get to keep the fees for the line in-house. The implicit guarantee of the stable value is much more important. […]

  13. […] is a follow-up to my previous article, A Collateral Proposal, in which I suggested that MMFs be consolidated with the sponsors’ books for capital […]

  14. […] my own views on the subject, expressed in A Collateral Proposal and The Future of Money Market Regulation, I was most interested in his final […]

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