Bloomberg News

Rosengren Says Money Funds May Be Vulnerable to Europe

June 03, 2011

(Updates with further comments on funds in seventh paragraph.)

June 3 (Bloomberg) -- Federal Reserve Bank of Boston President Eric Rosengren said U.S. money-market mutual funds may be vulnerable to Europe’s debt crisis.

Money-market funds “have sizeable exposures to European banks, by virtue of holding the banks’ short-term debt,” Rosengren said today in a speech at Stanford University in Stanford, California. Some funds “are potentially sensitive to a disruption in the European banking system, should one arise from the fiscal and sovereign-debt problems we are seeing.”

Concerns that money funds could hurt stability haven’t been adequately addressed by Congress or regulators to prevent a recurrence of the outflows after the bankruptcy of Lehman Brothers Holdings Inc. in 2008, Rosengren said. The Dodd-Frank Act passed last year mandated the Fed to monitor emerging risks to financial stability in the wake of the U.S. recession that ended two years ago.

“The set of issues surrounding” money funds “is in sum a vulnerability that needs to be addressed,” Rosengren, 54, said.

Money-market mutual fund assets totaled $2.73 trillion as of this week, according to the Washington-based Investment Company Institute.

European Union and International Monetary Fund officials have agreed to pay the next installment to Greece under last year’s 110 billion-euro ($161 billion) bailout, and will focus on wrapping up a new bailout package to prevent the euro area’s first sovereign default. The EU and IMF have also arranged rescue packages for Ireland and Portugal to stop the spread of the crisis.

Address Vulnerability

One solution to address the vulnerability of money market funds would be to “think about extending insurance” to them, Rosengren said in response to a question after the speech. However, there isn’t much political will to do something like that and other solutions are more viable, he said, such as forcing them to hold capital cushions or allowing the net asset value of the funds to float.

Speaking about the U.S. economy, Rosengren said “it’s been a very slow and halting recovery that we’ve experienced to date,” similar to the pace after previous financial crises.

Regulators are seeking to determine what companies could cause problems to the overall financial system, and which types of asset price movements could be threats. Federal Reserve Vice Chairman Janet Yellen said on June 2 that growth in syndicated loans needs to be monitored, while Kansas City Fed President Thomas Hoenig has said he’s watching rising farmland prices.

Threaten Stability

Rosengren, a former bank regulator before becoming president of the Boston Fed in 2007, said rising asset prices may threaten stability only if they impair credit. For example, recent “dramatic” rises and declines in the price of silver indicate the volatility of commodities prices without requiring any policy response, he said.

The Boston Fed chief said he agreed with the view of economists Carmen Reinhart and Kenneth Rogoff, co-authors of the 2009 book “This Time Is Different,” that recoveries following recessions caused by financial crises tend to be slower than normal.

One reason is that banks that experienced large losses may choose to shrink their balance sheets to improve their capital ratios rather than issuing new shares and diluting current shareholders, Rosengren said. That can reduce their willingness to lend and, if widespread, curb overall credit growth, he said.

Lenders may need to be required to have capital buffers which would not be rebuilt by shrinking loans, he said.

--Editors: Kevin Costelloe, Christopher Wellisz

Dakin Campbell in San Francisco at dcampbell27@bloomberg.net.

To contact the reporters on this story: Steve Matthews at smatthews@bloomberg.net

To contact the editor responsible for this story: Christopher Wellisz at cwellisz@bloomberg.net


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