Once Burned, Twice Shy: Money Market Fund Responses to a Systemic Liquidity Shock

Abstract

After Lehman's collapse in 2008, investors ran from risky money market funds. In 27 funds, outflows overwhelmed cash inflows, thus forcing asset sales. These funds sold their safest and most liquid holdings. Funds were thus left with riskier and longer maturity assets. Over the subsequent quarter, however, the hard-hit funds reduced risk more than other funds. In contrast, money funds hit by idiosyncratic liquidity shocks before Lehman did not alter portfolio risk. The result suggests that moral hazard concerns with the Treasury Guarantee of investor claims did not increase risk taking. Funds that benefited most from the government bailout reduced risk.

Is the EU Money Market Fund Regulation Fit for Purpose? Lessons from the COVID-19 Turmoil

“…A key vulnerability of MMFs arises from liquidity and maturity transformation (Ansidei et al (2012)). Moreover, MMFs may engage in risk-taking behaviour triggered by investors which reward funds that offer higher nominal returns by increasing the amounts invested in those funds (Chernenko and Sunderam (2014), Kacperczyk and Schnabl (2013) Therefore, MMFs holding a larger share of risky assets tend to experience higher outflows during crises periods than other MMFs that hold a less risky portfolio (Baba et al (2009), Jank and Wedow (2015), Strahan and Tanyeri (2015)). 4 We demonstrate that these mechanisms were also at play in European money market funds during the COVID-19-turmoil.…”

Money Market Fund Vulnerabilities: A Global Perspective

“…Second, if an MMF's portfolio contains only a limited share of liquid assets (as is the case for prime funds in the United States and non-publicdebt funds elsewhere), investors who redeem early in stress can enjoy a first-mover advantage. Indeed, U.S. prime MMFs that suffered heavy redemptions in 2008 sold their safest and most liquid holdings first, leaving the investors who did not redeem with riskier, less-liquid assets (Strahan and Başak, 2015).…”

Money Market Funds and Regulation

“…Lehman Brothers declared bankruptcy and investor concerns about the solvency of American International Group, Inc. and other financial-sector securities led to heavy redemptions from about a dozen MMFs that held, or were expected to be holding, bank-issued short-term commercial paper. The largest of these was the Reserve Fund, whose Primary Fund series held a $785 million position in Lehman Brothers commercial paper (Wermers 2012;Strahan & Tanyeri 2013;Schmidt, Timmerman & Wermers 2015). The capital loss associated with the failure of Lehman Brothers caused the Primary Fund to break the buck.…”