Money Market Funds and Systemic Risk

On September 16, 2008, Reserve Primary Fund, a money market fund (MMF) with $65 billion in assets under management, announced that losses in its portfolio had caused the value of shares in the fund to drop from $1.00 to $0.97. The news that an MMF had ?broken the buck? spread panic quickly to other MMFs. In the two days following Reserve?s announcement, investors withdrew approximately $200 billion (10 percent of assets) from so-called ?prime? MMFs, which, like Reserve, mainly invest in privately issued short-term securities. The massive redemptions and resulting strains on MMFs contributed to a freezing of the markets that provide short-term credit to businesses and financial institutions and a sudden spike in short-term interest rates. Responding to these severe disruptions, the Treasury Department intervened on September 19 with a government guarantee of the value of MMF shares, and the Federal Reserve announced on the same day a facility designed to provide liquidity to MMFs. These unprecedented actions stopped the run on MMFs (for more analysis of the run in 2008, see McCabe, 2010). In this post, we discuss why MMFs are a source of financial fragility and the need for reforms to mitigate the risks they pose to the financial system and the economy.