Fix Money Funds Now

On September 19, 2008, at the height of the financial crisis, the U.S. Treasury announced that it would guarantee the liabilities of money market mutual funds (MMMFs). And, the Federal Reserve created an emergency facility (“Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility”) to finance commercial banks’ purchases of illiquid MMMF assets. These policy actions halted the panic.

That episode drove home what we all knew: MMMFs are vulnerable to runs. Everyone also knew that the Treasury and Fed bailout created enormous moral hazard. Yet, the subsequent regulatory efforts to make MMMFs more resilient and less bank-like have proven to be half-hearted and, in some cases, counterproductive. So, to halt another run in March 2020, the Fed revived its 2008 emergency liquidity facilities.

We hope the second time’s the charm, and that U.S. policymakers will now act decisively to prevent yet another panic that would force yet another MMMF bailout.

In this post, we briefly review key regulatory changes affecting MMMFs over the past decade and their impact during the March 2020 crisis. We then discuss the options for MMMF reform that the President’s Working Group on Financial Markets identifies in their recent report. Our conclusion is that only two or three of the report’s 10 options would materially add to MMMF resilience. The fact that everyone has known about these for years highlights the political challenge of enacting credible reforms.

Money Funds -- The Empire Strikes Back?

Shortly after Lehman failed in 2008, investors began to flee from money market mutual funds (MMMFs). To halt the run, the U.S. Treasury guaranteed all $3.8 trillion in outstanding MMMF liabilities. That rescue created enduring moral hazard: the expectation that a future crisis will lead to another bailout.

Aside from their legal form as mutual funds, MMMFs functioned much like banks engaged in the transformation of liquidity, credit and (to some extent) maturity. Similar to banks that redeem deposits at face value, they promised investors a fixed share value of $1 (a “buck”) on demand. Unlike depositories, however, MMMFs had no capital, no deposit insurance, and—at least officially—no access to the lender of last resort. So, when the Reserve Primary Fund “broke the buck” (by failing to redeem at the $1 par value) in September 2008, MMMF investors panicked.

Somewhat surprisingly, it took until 2014 for the Securities and Exchange Commission (SEC) to resolve political conflicts and introduce significant rule changes for MMMFs (see our earlier posts here and here). The SEC now requires that institutional prime MMMFs—which (like Reserve Primary) frequently invest in short-term corporate liabilities—operate like other mutual funds with a floating net asset value (NAV). The same rule applies to institutional municipal MMMFs. Retail MMMFs, as well as those investing in federal government (and agency) securities, are exempt.

In light of a recent legislative proposal to water it down, in this post we review the impact of the SEC’s 2014 reform. To highlight our conclusions: (1) it did not go far enough to reduce run risk; (2) aside from temporary dislocations, it has not raised nonfinancial sector funding costs by more than would be accounted for by reducing the implicit taxpayer guarantee for MMMFs; and (3) reversing the floating-NAV requirement would weaken the safety of the U.S. financial system....

Commentary

Money, Banking, and Financial Markets