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

_IMF Blog, November 10, 2010_

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## Bibliographic details
- Authors: Jeanne Gobat
- Published: November 10, 2010

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### Role of money market mutual funds in the crisis
- 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.

### Reforms implemented since the crisis
- 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.

### Assessment of post-crisis measures
- 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.

### Options for addressing systemic industry risk
- 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.

### Advantages of moving to a floating NAV
- 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.

### Core policy message
- 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*

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## References

- [Global Financial Stability Report](http://www.imf.org/external/pubs/ft/gfsr/2010/02/index.htm)

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