Federally-Insured Money Market Funds and Narrow Banks: The Path of Least Insurance

Abstract:     
In September 2008, the Treasury created a temporary insurance program for money market funds ("MMFs"), which had never previously been covered by government insurance. This essay argues that this program should be made permanent. To the extent that deposit insurance is intended to protect cash accounts that provide a stable foundation for our payments system, similar insurance should be made available to MMFs, which serve this function while presenting less risk than bank deposits. The argument that only bank accounts should be insured because the liquidity they create for long-term ventures otherwise would dry up might once have made sense, but it no longer reflects modern financial markets where liquidity creation has become broadly diversified. Deposit insurance also should be made available to bank deposits backed by short-term assets (like MMFs) that would be relieved of burdens to which other bank deposits are subject, such as the Community Reinvestment Act.

Number of Pages in PDF File: 30

Keywords: bank, money market, money market fund, deposit insurance, FDIC, liquidity creation, payments system

JEL Classification: G18, G21, K22, K00, K23, G00

working papers series