The Cross Section of Money Market Fund Risks and Financial Crises

Abstract

This paper examines the relationship between money market fund (MMF) risks and outcomes during crises, with a focus on the ABCP crisis in 2007 and the run on money funds in 2008. I analyze three broad types of MMF risks: portfolio risks arising from a fund's assets, investor risk reflecting the likelihood that a fund's shareholders will redeem shares disruptively, and sponsor risk due to uncertainty about MMF sponsors' support for distressed funds. I find that during the run on MMFs in September and October 2008, outflows were larger for MMFs that had previously exhibited greater degrees of all three types of risk. In contrast, as the asset-backed commercial paper (ABCP) crisis unfolded in 2007, many MMFs suffered capital losses, but investor flows were relatively unresponsive to risks, probably because investors correctly believed that sponsors would absorb the losses. However, the consequences of MMF risks were quite costly for some sponsors: Using a unique data set of sponsor interventions, I show that sponsor financial support was more likely for MMFs that previously earned higher gross yields (a measure of portfolio risk) and funds with bank-affiliated sponsors. Funds' gross yields and bank affiliation (but not funds' ratings) also would have helped forecast holdings of distressed ABCP. This paper provides some useful lessons for investors and policymakers. The significance of MMF risks in predicting poor outcomes in past crises highlights the importance of monitoring such risks, and I offer some useful proxies for doing so. The paper also argues for greater attention to the systemic risks posed by the industry's reliance on discretionary sponsor support. * The opinions expressed are mine and do not necessarily reflect those of the Federal Reserve Board or its staff. I thank Alycia Chin for excellent research assistance. This paper also has benefitted from helpful comments and suggestions from

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

“…Consistent with other research (McCabe (2010), Kacperczyk and Schnabl (2013)), we start by showing that fund flows responded rationally to the sharp change in expectations about the risks of commercial paper investments. Due to its large exposure to Lehman Brothers' commercial paper, the Reserve Primary Fund "broke the buck" on Sept.…”

“…1 McCabe (2010) shows that runs were "rational" in that they were concentrated in high-risk funds, using reasonable measures of investment risk and the likelihood of sponsor support. Similarly, Schmidt, Timmermann, and Wermers (2013) find that runs were more pronounced among institutional investors, with such investors tending to move their money from a prime (risky) fund to a government (safe) fund, often within the same family.…”

“…Money funds, for example, may not purchase assets with maturity greater than 13 months, they must not have a weighted-average maturity greater than 60 days, and they must hold mainly highly rated instruments such as commercial paper, repos, and U.S. government securities. Moreover, many money market funds are sponsored by large financial institutions that have, in a few cases before 2008, stepped in to support their funds rather than allow investors to experience losses of principal (McCabe (2010)). Brady, Anadu, and Cooper (2012) systematically study parent-firm noncontractual support (in the form of a cash contribution or a purchase of fund securities at above-market prices) to their money market funds from 2007 to 2011.…”

Shadow Banking and the Funding of the Nonfinancial Sector

“…Pozsar et al (2010) gives an overview of the shadow banking system, Pozsar (2011) provides information on investors' pools of cash, and Ricks (2011) examines the growth of private money claims. Others have examined particular instruments used in shadow banking, such as repurchase agreements (Gorton and Metrick, 2010), assetbacked commercial paper (Covitz, Liang, andSuarez, 2009 andAcharya, Schnabl, andSuarez, 2011), auction rate securities and variable-rate demand notes (Han and Li, 2010), and money market mutual funds (McCabe, 2010).…”

The dynamic relationship among the money market mutual funds, the commercial paper market, and the repo market

“…?, He and Xiong (2012), Gennaioli et al (2013), andMcCabe (2010) consider the role of the MMFs during the financial crisis and modeled runs in the MMFs. Parlatore Siritto (2015) presents a model to analyze the impact of the regulations on the shadow banking system.…”