Breaking the Buck—Reducing Systemic Risks Posed by Money Market Mutual Funds

IMF Blog, November 10, 2010

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The breakdown of the short-term funding markets was a striking feature of the global financial crisis and U.S. money market mutual funds played a central role in contributing to a wholesale shut-down.
Following the bankruptcy of Lehman Brothers in the fall of 2008, financial institutions found it extremely difficult to borrow short-term cash even against relatively low-risk assets.
Key investors in short-term funding—the money market mutual funds—started leaving the market, demanding higher margins on repurchase transactions and requiring asset-backed commercial paper to be backed by more secure collateral (cash reserves or other assets).
Redemptions were triggered by the failure of the Reserve Primary Fund to maintain its “net asset value” (NAV) at par, or above the US$1 per share price. (Share prices falling below US$1 ―known as “breaking the buck”― can trigger massive redemptions as funds are forced to sell underlying assets at increasingly lower prices and realize losses.)
Disruptions affected many non-U.S. banks that relied heavily on the U.S. wholesale market to fund their dollar-denominated assets.
Almost overnight it became apparent that market participants and regulators did not fully understand the central and systemic role of money market mutual funds; the U.S. government responded with extraordinary steps to stabilize the industry.

New rules in the United States aim to minimize the risk of another run by investors.
The U.S. Securities and Exchange Commission modified Rule “2a-7 Funds” governing mutual funds to impose:
- constraints on asset quality,
- new liquidity rules,
- restrictions on collateral acceptable for repo operations.

The measures will lower the industry’s risk profile in the short term.
However, these measures do not sufficiently mitigate the system-wide risks posed by the money market mutual fund sector.
Principle stated: financial institutions that contribute to systemic liquidity risk and that offer typical banking services should be set up and regulated as banks.

Option 1: Re-license money market mutual funds as banks while they retain bank-like business activity.
- Would require substantial changes in structure, capitalization, and regulation.
Option 2 (preferred by author): Move money market mutual funds, over time, to a floating NAV.
- Described as a less fundamental change with several clear advantages.

Clarifies that market risks are borne by the investor, unlike a bank deposit backed by public deposit insurance.
Removes special treatment favoring money market mutual funds relative to commercial banks, addressing “level playing field” concerns.
Helps eliminate the “first-mover advantage” that fuels destabilizing runs—early redemptions being paid at par while later investors bear disproportionate losses when actual asset values are lower.

Provide a clear signal to investors that placements in money market mutual funds are different than bank deposits.
With more accurate information about risks, investors are less likely to allocate money to these funds under false pretenses.
Reducing the systemic component of bank funding posed by these funds should lower the likelihood of a similar system-wide funding problem in the future.

Source: https://www.imf.org/en/blogs/articles/2010/11/10/breaking-the-buck-reducing-systemic-risks-posed-by-money-market-mutual-funds