Reforming Money Market Mutual Funds

Here’s a new proposal from Sam Hanson, David Scharfstein, and Adi Sunderam.

We analyze the leading reform proposals to address the structural vulnerabilities of money market mutual funds (MMFs). We take the main goal of MMF reform to be safeguarding financial stability. In light of this goal, reforms should reduce the ex ante incentives for MMFs to take excessive risk and increase the ex post resilience of MMFs to system-wide runs. Our analysis suggests that requiring MMFs to have subordinated capital buffers best accomplishes these goals. Subordinated capital provides MMFs with loss absorption capacity, lowering the probability that a MMF suffers losses large enough to trigger a run, and reduces incentives to take excessive risks. We estimate that a capital buffer in the range of 3 to 4% would significantly reduce the probability that ordinary MMF shareholders ever suffer losses. In exchange for having the safer investment product made possible by subordinated capital, the yield paid to ordinary MMFs shareholders would decline by only 0.05%. Capital buffers would generate significant financial stability benefits, while maintaining the current fixed net asset value (NAV) structure of MMFs. Other reform alternatives such as converting MMFs to a floating NAV would be less effective in protecting financial stability.

About ozidar

I'm an Assistant Professor of Economics at the University of Chicago Booth School of Business and a Faculty Research Fellow at National Bureau of Economic Research. You can follow me on twitter @omzidar.
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1 Response to Reforming Money Market Mutual Funds

  1. WaltFrench says:

    Interesting idea.

    I wonder if it could be contrasted to the prior practice whereby banks who owned MMFs de facto guaranteed the $1.00 NAV (but not explicitly): did they set aside risk capital or actively buy insurance from another firm, to back their willingness to cover the funds in the event of losses?

    Overall, I think it very helpful for institutions to be explicit about the depth of their backing of MMFs. But it’s not clear that any specific backing percentage will be enough to always guarantee against a run, with the potential meltdown effects that forced the Fed to supply ex post facto deposit insurance against; there may ALWAYS be a need for socialized losses.

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