VoxEU.org, a website for the Centre for Economic Policy Research, published a brief entitled, "Runs on prime money funds during the COVID-19 crisis." Written by Lei Li, Yi Li, Marco Macchiavelli and Xing (Alex) Zhou, the piece explains, "Liquidity restrictions on investors, like the redemption gates and liquidity fees introduced in the 2016 money market fund (MMF) reform, are meant to improve financial stability during a crisis. However, by comparing the latest outflow episode due to COVID-19 to those in 2008 and 2011, this column finds evidence that these liquidity restrictions might have exacerbated the run on prime MMFs in this episode. Such severe outflows amid frozen short-term funding markets led the Federal Reserve to intervene with the Money Market Mutual Fund Liquidity Facility (MMLF). By providing 'liquidity of last resort', the MMLF successfully stopped the run on prime MMFs and gradually stabilised conditions in short-term funding markets." (See also Bloomberg's "Shadow Bank Weaknesses Forced Fed’s Market Rescue, Quarles Says".)
The Fed economists' paper explains, "Money market funds (MMFs) are an important source of short-term funding for governments, corporations, and banks (Hanson et al. 2015) and play a notable role in the monetary policy transmission as part of the shadow banking system (Xiao 2020). The resilience of the MMF industry has profound implications for the stability of the financial system. In the aftermath of the 2007-09 financial crisis, the Securities and Exchange Commission (SEC) introduced a set of reforms to address the vulnerabilities of the money funds which were exposed during the crisis. In particular, the 2016 MMF reform introduced new liquidity rules for prime MMFs, which are major investors in the commercial paper (CP) and negotiable certificates of deposit (CDs) markets. This reform allows prime MMFs to impose redemption gates and liquidity fees on their investors once their liquidity buffers, namely weekly liquid assets (WLA) that could be converted into cash within a week, fall below 30% of total assets."
It continues, "The intention of such reforms is to endow MMFs with tools to stop investor runs on their own. Their proponents, including then-SEC Chair Mary Jo White, argued that redemption gates and liquidity fees would 'mitigate [the run] risk and the potential impact for investors and markets.' However, their critics noted that the possibility of MMFs introducing gates and fees can incentivise investors to run preemptively before such liquidity restrictions are imposed. For example, SEC Commissioner Kara Stein suggested that allowing funds to impose gates and fees 'could actually increase an investor's incentive to redeem,' especially in a crisis."
The article continues, "The COVID-19 crisis provides the first major event to empirically study the impact of the contingent liquidity restrictions introduced by the 2016 MMF reform on the stability of the MMF industry. In late February 2020, with increasing COVID-19 cases in the US and Europe, capital markets started to experience turmoil (e.g. Ramelli and Wagner 2020). By mid-March, yield spreads on various short-term funding securities, including CP and CDs, had surged to levels last seen during the 2008 financial crisis.... Amid the broad risk-off sentiment, investors started to run on prime MMFs. Within two weeks from 9 March 2020, $96 billion (about 30% of assets under management) were withdrawn from institutional prime MMFs."
It tells us, "In a recent paper (Li et al. 2020), we study the anatomy of the run on institutional prime MMFs during the COVID-19 crisis to understand how contingent redemption gates and liquidity fees might have changed money funds' run risk. We start by comparing the run during the COVID-19 crisis to the previous two prominent MMF runs, namely the run surrounding the September 2008 Lehman bankruptcy and the euro area sovereign debt crisis run in the summer of 2011. The COVID-19 and 2008 runs are remarkably similar in terms of speed and intensity, with institutional prime funds losing more than 30% of assets in about 20 days ... while the 2011 run is relatively milder and more gradual."
The piece states, "We find that fund outflows were highly sensitive to fund liquidity holdings during the 2020 crisis (i.e. funds with low WLA experienced larger outflows), but such a relationship was absent in either the 2008 or 2011 crisis. More interestingly, when we split funds into high (top quartile), middle, and low (bottom quartile) WLA groups, we find greater flow sensitivity to WLA among low-WLA funds in 2020. In other words, the flow sensitivity to fund liquidity is greater for lower-liquidity funds only after the 2016 MMF reform allowed for the imposition of gates and fees. These findings suggest that the contingent liquidity restrictions might have exacerbated the run during the 2020 COVID-19 crisis."
Lastly, the paper adds, "The run on prime MMFs led them to hoard liquidity and refrain from investing in instruments with maturities longer than one week, putting further pressure on the already strained CP and CD markets. In response to the precarious conditions in money markets, the Federal Reserve intervened with the Money Market Mutual Fund Liquidity Facility (MMLF). The MMLF enabled MMFs to liquidate some of their assets to meet redemptions and increased their confidence in investing in longer-tenor securities. We find that the MMLF was effective at stemming outflows from MMFs.... The recent COVID-19 crisis highlighted that ex-ante liquidity restrictions might not achieve the goal of creating a system immune from runs. Given the notable role of MMFs in the short-term funding markets and in the shadow banking system, more research and collaborative regulatory efforts are warranted to enhance the stability of the industry."
In other news, money market fund assets plunged in the latest week on tax-related outflows, their 7th decline in 8 weeks. Since the week ended May 20, assets have fallen by $221.0 billion, but this follows 15 straight weeks of inflows (during which time assets increased by $1.172 trillion). ICI's latest weekly "Money Market Fund Assets" report says, "Total money market fund assets decreased by $87.38 billion to $4.57 trillion for the week ended Wednesday, July 15, the Investment Company Institute reported.... Among taxable money market funds, government funds decreased by $76.36 billion and prime funds decreased by $6.37 billion. Tax-exempt money market funds decreased by $4.65 billion." ICI's stats show Institutional MMFs decreasing $74.5 billion and Retail MMFs decreasing $12.9 billion. Total Government MMF assets, including Treasury funds, were $3.686 trillion (80.7% of all money funds), while Total Prime MMFs were $758.5 billion (16.6%). Tax Exempt MMFs totaled $124.1 billion, 2.7%.
Money fund assets are up an eye-popping $936 billion, or 25.8%, year-to-date in 2020, with Inst MMFs up $762 billion (33.7%) and Retail MMFs up $174 billion (12.7%). Over the past 52 weeks, ICI's money fund asset series has increased by $1.306 trillion, or 40.1%, with Retail MMFs rising by $293 billion (23.4%) and Inst MMFs rising by $1.014 trillion (50.4%).
They explain, "Assets of retail money market funds decreased by $12.85 billion to $1.54 trillion. Among retail funds, government money market fund assets decreased by $3.54 billion to $980.45 billion, prime money market fund assets decreased by $5.80 billion to $452.53 billion, and tax-exempt fund assets decreased by $3.51 billion to $110.99 billion." Retail assets account for just over a third of total assets, or 33.8%, and Government Retail assets make up 63.5% of all Retail MMFs.
ICI adds, "Assets of institutional money market funds decreased by $74.53 billion to $3.02 trillion. Among institutional funds, government money market fund assets decreased by $72.82 billion to $2.71 trillion, prime money market fund assets decreased by $573 million to $305.97 billion, and tax-exempt fund assets decreased by $1.14 billion to $13.09 billion." Institutional assets accounted for 66.2% of all MMF assets, with Government Institutional assets making up 89.5% of all Institutional MMF totals. (Note: Crane Data has its own separate daily and monthly asset series.)
