Money Market Mutual Funds and Financial Stability
In the wake of Lehman Brothers’ failure in September 2008, a money market mutual fund (MMMF) called the Reserve Primary Fund experienced substantial outflows. Investors were concerned about the fund’s credit exposure to Lehman. More specifically, investors were concerned that losses from the Lehman exposure would cause Reserve Fund to “break the buck” (that is, redeem shares for less than one dollar) and violate MMMFs’ implicit promise of being as safe as bank deposits. Problems at Reserve Fund also triggered large withdrawals from other MMMFs. In response to these runs, the Treasury Department and the Federal Reserve stepped in with the Exchange Stabilization Fund and the ABCP Money Market Mutual Fund Liquidity Facility (AMLF), respectively. These programs considerably mitigated the outflows.
Five years after the crisis, where do MMMFs stand? Are they taking on sources of risk that could pose a problem in the future? Are they sufficiently liquid to deal with sudden outflows or runs? The riskiness of the funds and their ability to meet sudden liquidity requirements are two litmus tests of stability and resiliency for the financial industry. In this article, we address these questions by comparing the aggregate portfolios of two types of MMMFs, prime institutional and prime retail funds, before and after the crisis. Prime funds are MMMFs that are invested primarily in private credit instruments as opposed to US Treasuries and federal agency and tax-exempt securities. The terms institutional and retail refer to the investors—institutions or individuals. During the 2008 financial crisis, prime funds were the most affected type of MMMF and suffered the most disruption due to losses in private credit investments. We also examine the liquidity position of prime funds in 2011 (when the data became available).
Looking at the average composition of prime institutional MMMFs’ portfolios, we can see that commercial paper holdings have clearly declined below pre-crisis levels. Well before the crisis, in 2005:Q1, asset-backed commercial paper (ABCP) constituted 12 percent of the average portfolio of prime institutional MMMFs, while Tier-1 commercial paper excluding ABCP made up 24 percent of the portfolio (jointly 36 percent). Just prior to the crisis, Tier-1 and asset-backed commercial paper formed about 43 percent of the institutional portfolio. Currently, Tier-1 commercial paper and ABCP jointly constitute 32 percent of the institutional portfolio. Holdings of floating-rate notes have also declined from 23 percent to 13 percent for prime institutional funds. Foreign bank obligations have risen steadily from 7 percent in the pre-crisis period to 22 percent as of 2014:Q1.
Turning to the portfolio composition of prime retail MMMFs, we can see patterns similar to those of the prime institutional funds. Foreign bank obligations have risen steadily from 5 percent to 14 percent. In addition, the share of foreign bank obligations in the portfolios of both retail and institutional funds has steadily risen since 1995, from 6 percent to over 17 percent.
To assess liquidity conditions in the MMMFs, we use data from new reports that MMMFs are required to file. The Securities and Exchange Commission (SEC) started collecting information on prime funds’ liquidity positions in 2011 through Form N-MFP. Data gathered from this form suggest that the liquidity positions of prime funds have weakened somewhat since 2011. Daily liquid assets formed 30 percent of the prime portfolio in 2012:Q3. Weekly liquid assets formed 45.4 percent of the prime portfolio in 2012:Q4. As of 2014:Q1, daily liquid assets comprised 23.2 percent of the prime portfolio, and weekly liquid assets comprised 36.7 percent of the portfolio. The liquidity of assets is likely to fluctuate based on varying maturities of the assets held. However, it is important to ensure that there are no huge fluctuations in the daily and weekly liquidity positions of prime portfolios.
Given their current aggregate portfolios and liquidity positions, MMMFs seem to pose no serious threats to financial stability at the moment. However, we must keep a vigilant watch on the MMMFs’ holdings of liquid funds. Large fluctuations in liquid-fund holdings can pose a threat in the event of financial stress, which can in turn lead to financial instability.
Rosengren, Eric, (2012), Money Market Funds and Financial Stability: Remarks at the Federal Reserve Bank of Atlanta’s 2012 Financial Markets Conference, Stone Mountain, Georgia.
Ennis, H.M., and Haltom, R., (2014), Reforming Money Market Mutual Funds: A Difficult Assignment, Federal Reserve Bank of Richmond Economic Brief, EB14-02.