The Cross Section of Money Market Fund Risks and Financial Crises

63 Pages Posted: 1 Oct 2010

See all articles by Patrick E. McCabe

Patrick E. McCabe

Board of Governors of the Federal Reserve System

Multiple version iconThere are 2 versions of this paper

Date Written: September 12, 2010

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.

Keywords: Money Market Fund, Mutual Fund, ABCP, Asset-Backed Commercial Paper, Financial Crisis, Risk, Lehman

JEL Classification: G01, G20, G23, G28

Suggested Citation

McCabe, Patrick E., The Cross Section of Money Market Fund Risks and Financial Crises (September 12, 2010). FEDS Working Paper No. 2010-51. Available at SSRN: https://ssrn.com/abstract=1684802 or http://dx.doi.org/10.2139/ssrn.1684802

Patrick E. McCabe (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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