RD News 5Dec11

• MMFs: Floating NAV and redemptions – Letter to President’s Working Group
• The debate on whether to compel a floating NAV is misplaced and rests on erroneous assumptions. The $​1 NAV is not, and has never been, fixed or divorced from market value.
• As is true for share prices of all mutual funds, the price of MMF shares is, of necessity, a rounded price. Stock and bond funds round their NAVs to the nearest cent; MMFs round their shares to a $​1 NAV if, and only if, the market value of their portfolio equals or exceeds 99.​5 cents per share.
• The run on MMFs unleashed in 08 was animated by investors' (​more particularly, institutional investors') fear over the loss of liquidity, not the loss of principal. Indeed, the liquidation of the Reserve Primary Fund -- which substantially delayed investors' access to their money despite the fact that their eventual losses were less than 1% -- bears this out.
• Propose measure to  address liquidity concerns once a fund has broken the buck:
•  A fund'​s board must promptly decide whether to operate the fund with a fluctuating NAV or liquidate the fund.
• If the former course is chosen, investors should be free to redeem their shares, just as investors in ultra-​short bond funds would be able to do.
• If the latter course is chosen, a fund board should not have the unfettered right to suspend redemptions indefinitely.
• The SEC should amend its rules to permit full suspension of redemptions for only two days following the breaking of the buck; for three days thereafter, suspension of redemptions should be limited to no more than 50% of a shareholder'​s shares.
• Thereafter, shareholders in the fund should be free to redeem up to 90% of their shares, based upon a floating NAV.

• IMF working paper: How costly are debt crises?
• Debt crises are associated with persistent output losses: eight years after the occurrence of a debt crisis, output is lower by about 10%.
• Results suggest that debt crises tend to be more detrimental than banking and currency crises.

• IMF working paper: Market Discipline and Conflicts of Interest between Banks and Pension Funds
• Pension funds exert market discipline and this discipline gets stronger as the share of pension fund deposits in a bank rises.
• However, conflicts of interest undermine the disciplining role of pension funds. Specifically, pension funds allocate deposits to banks with weak fundamentals that own pension fund management companies.
• Forbidding banks’ ownership of companies involved in pension fund management can enhance market discipline.

• Donald Kohn (BoE’s FPC): Crisis Memory May Spur Drive for New Bank Regulations 
• Challenges of conducting macroprudential policy in good times -- taking away the prudential punch bowl as the party gets going.
• Banks must not try to bolster their strength by reducing the availability of credit to U.K. companies or households, even in periods of stress.
• On FPC recommendation that banks disclose leverage ratios to investors by the start of 2013, two years earlier than Basel III requires: ‘it will help counterparties evaluate risk, bolster market discipline, and provide greater incentive for U.K. banks to raise capital and constrain leverage.’