Do Money Market Funds Require Further Reform?

Abstract

The merit of further reform of money market funds by the SEC hinges on the extent to which runs on prime funds pose an investor-protection problem. Reformers assume that the many runs on prime funds in 2008 reflected rational inter-shareholder opportunism, but there is no evidence that retail investors need more protection from this. Notably, the non-redeeming shareholders of the Reserve Primary Fund were the only fund shareholders damaged in the runs on prime funds in 2008, and their avoidable loss amounted to just 1/3rd of one percent of their investment. Still, one-quarter of prime funds in 2008 had a mix of retail and (run-prone) institutional shareholders in the same fund. As the rest did not, this hypothetical hazard is unnecessary and the industry should act voluntarily to eliminate mixed-clientele prime funds. More importantly, now that bank-issued money market instruments have come to comprise half the holdings of the typical prime fund, the SEC should acknowledge correlated credit risk by requiring that prime funds practice sector diversification (in addition to issuer diversification). Money market funds should be made less important as financing arms of TBTF banks, not made more reliable as financing arms of TBTF banks.

Keywords: money market, regulation, systemic risk, investor protection

JEL Classification: G10, G18, G20