How Money Market Mutual Funds Contributed to the 2008 Financial Crisis Essay

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Money Market Mutual Funds (MMMF)

MMMF are open-end mutual funds in which investors can easily access their invested funds through the redemption of shares [1] [2]. Redeeming a share is the situation where the investors demand the cash equivalent of the invested share. In fact, MMMF is channeling through which predetermined earnings are devoted to debt securities. The major attributes of the debt securities are their quick-fix maturities as well as nominal credit risks [1]. Some of the debt securities are assessable. The examples of the debt securities within the MMMF portfolio range from U.S. Treasury securities to Eurodollar deposits. Within the continuum includes a range of securities such as the certificate of deposits (CDs) [1].

The Systemic Risks Created by MMMF Industry during the 2008 Financial Crisis

During the 2008 crisis, the MMMF held over 50% of the total deposits and were significant financial sources for short-term bank paper and repo agreements [3]. For a long time, MMMF had been taken as a perfect substitute for deposits due to their capability of holding the value of the share at $1. During the 2008 financial crisis, the majority of investors withdrew a large quantity of their invested funds resulting in a rare occurrence known as the ‘breaking the buck’, which is a liquidity phenomenon where the value of share prices drops below the required minimum of $1 [3] [4]. The fall of the value of shares below the target price caused great concern to the investors and the regulators. While how the prices of shares fell below the set $1 per share was a complex process, it became one of the greatest systemic risks posed by the MMMF to the investors and the economy during the 2008 financial crisis [4].

The Actions Taken by the Treasury and Federal Reserve Bank (FRB) to Reduce the Risks of MMMF during the 2008 Financial Crisis

The continued vulnerability of the MMMF provoked the financial regulators to establish new policies aimed at controlling MMMF. The measures taken by the treasury and the FRB were concerned with monetary and fiscal policies rather than regulations on the actions of the MMMF [5]. However, following various legislations on monetary issues, the treasury was allowed to prohibit the operations of the Exchange Utilization Fund (EUF) for the establishment of guarantees by the MMMF [5] [6].

Besides the measures taken by the treasury, the FRB established a Commercial Paper Funding Facility (CPFF) that would directly buy the commercial papers from qualified issuers instead of MMMF [5] [6]. In addition, the FRB created the Money Market Mutual Investor Fund Facility (MMMIFF) that enabled the private sectors to directly purchase the money market instruments from the MMMFs [6].

The New Regulations being Proposed and Implemented by Securities and Exchange Commission (SEC) to Mitigate the Risk from Occurring

The SEC is also one of the regulatory institutions that put in place new measures to mitigate the risks posed by the actions of the MMMF. Following the continued vulnerability of the MMMF, SEC came up with three regulatory changes that have been implemented since 2008. The dogmatic changes could be categorized into three types including changes that focused on risk limitations, increased strict control of the repurchase agreements, and the special provisions for MMMF that target the minimum share prices [7][8]. In particular, under the regulations that target the minimum set on share prices, the MMMF are permitted by SCE to utilize different accounting procedures to come up with the value of securities that offer a stable share of $1.00 [7][8].

References

  1. ” Investopedia. Web.
  2. “Money market mutual funds and financial stability” Federal Reserve Bank of Cleveland, 2014. Web.
  3. ” Liberty Street Economics., 2012. Web.
  4. “Reducing systemic risk: The role of money market mutual funds as substitutes for federally insured bank deposits” Yale Law School, Connecticut. Web.
  5. “Reforming money market mutual funds: A difficult assignment” Economic Brief, 2011. Web.
  6. “The response of the federal reserve to the recent banking and financial crisis” University of Chicago, Chicago. Web.
  7. “Money market mutual funds and financial stability” Federal Reserve Bank of Boston. 2011. Web.
  8. “The crisis and the policy response” Federal Reserve Bank. 2009. Web.
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IvyPanda. 2022. "How Money Market Mutual Funds Contributed to the 2008 Financial Crisis." April 10, 2022. https://ivypanda.com/essays/how-money-market-mutual-funds-contributed-to-the-2008-financial-crisis/.

1. IvyPanda. "How Money Market Mutual Funds Contributed to the 2008 Financial Crisis." April 10, 2022. https://ivypanda.com/essays/how-money-market-mutual-funds-contributed-to-the-2008-financial-crisis/.


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