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.