Earlier this month, we excerpted from a Federal Reserve Bank of New York report, "Money Market Fund Vulnerabilities: A Global Perspective." (See our March 21 News, "NY Fed Paper: Money Market Fund Vulnerabilities: A Global Perspective," and our March 24 News, "NY Fed Report Reviews Origins of MMFs in U.S., Europe, Japan, China.") Today, we quote from the section involving "MMF crises." The NY Fed writes, "Crises have arisen in MMFs around the world, particularly since 2000. Although each crisis event has reflected the particular characteristics of a jurisdiction's MMFs and how they were regulated at the time, some common themes emerge. Investors and even regulators in many cases appear to have been surprised that MMFs were not as safe and money-like as they had been perceived. Investors often respond by running from MMFs even though losses – if any – are typically small relative to losses that can occur in other types of investment funds. Institutional investors are especially fast to run, and investors who redeem early are typically at an advantage relative to others. The range of events also shows that MMF crises are not unique to a particular jurisdiction or regulatory regime, and that runs still occur even after authorities have introduced new restrictions to respond to past crises." (Note: Thank you to those who attended our Bond Fund Symposium this week in Newport Beach, Calif.! We hope you enjoyed the show.... Visit our "Bond Fund Symposium 2022 Download Center" for materials and recordings.)
They explain, "Early examples of strains in MMFs often involved exposures to assets with credit and interest rate risks, including some that are no longer considered appropriate for MMFs to hold. Some of these episodes nonetheless highlight that even small losses – or the threat of losses – can cause sudden loss of moneyness in MMFs and disproportionate reactions by investors.... Between 1989 and 2003, sponsors stepped in voluntarily more than 140 times to support MMFs that held defaulted debt or other assets that had lost value. For example, in 1989 and 1990, several MMF sponsors purchased defaulted CP from their funds at par (SEC, 1990; Moody's, 2006; ICI, 2009). Meanwhile, shareholders over these years suffered losses only in one instance, in 1994, when the Community Bankers' U.S. Government Money Market Fund ... 'broke the buck' -- that is, its share price fell below $1.00."
The paper tells us, "During this period, the SEC responded to each wave of distress and sponsor support with new rules or other actions designed to limit risks that had just become apparent. For example, amendments to rule 2a-7 were adopted in 1991 in the wake of the 1989-1990 CP defaults to tighten diversification requirements and again in 1996 after losses stemming from the Orange County bankruptcy led to sponsor support for several dozen MMFs (ICI, 2009)."
It states, "As Enron collapsed in late 2001, five JMMFs that held Enron's Euroyen bonds suffered losses that caused them to 'break the buck' -- that is, their share prices dropped below their normal ¥10,000 NAVs. One fund fell to ¥9,319.... Investors responded by redeeming shares en masse, and JMMF assets shrunk by 58 percent from October to December and continued falling thereafter.... While the JMMF holdings of Enron reflected the particularly lax rules for these money funds, this episode illustrates broader vulnerabilities and patterns.... Enron obligations in the Sumisei MMF climbed from 2.2% of the assets at the end of October to 5.3% near the end of November, as the fund met heavy redemptions by selling other assets."
Discussing the "European Union," the piece says, "In the summer of 2007, 'enhanced' and 'dynamic' MMFs in France, Luxembourg, and Germany suffered mark-to-market losses and difficulty valuing certain portfolio assets, including asset-backed subprime mortgage securities. Some asset managers intervened to support their funds, while others suspended redemptions and imposed losses on investors. For example, following significant losses on subprime mortgages, Luxembourg-based AXA Investment Management offered to purchase all shares in two of its enhanced MMFs at the prevailing NAV, and French asset manager ODDO suspended redemptions in its enhanced MMFs, liquidated the funds, and protected retail investors from losses. BNP suspended redemptions in three MMFs and eventually reopened them with haircuts of between 1 and 2 percent of NAV. Some German asset managers suspended redemptions for their enhanced MMFs, as well."
It continues, "In the second half of 2007 and early 2008, some MMF sponsors provided support to their MMFs either by purchasing assets directly from the fund's portfolios or by guaranteeing the value of the MMF shares to investors. At the crisis intensified, sponsor support increased. At least 26 MMFs received support between August 2007 and the end of 2009 (Moody's, 2010). Support actions resulted in large losses for asset managers and their parent banking groups, leading to contagion from MMFs to the banking system (Bengtsson, 2013; McCabe, 2010)."
Back in the U.S., they explain, "In the aftermath of the 2007 crisis in the market for asset-backed CP (ABCP), SEC records indicate that 44 MMFs received support due to holdings of distressed ABCP. Despite news of substantial MMF exposure to these securities, MMF investors did not run from the funds during the ABCP crisis, as sponsor support – even though it was discretionary – evidently convinced investors that MMFs were safe.... U.S. prime MMFs attracted large inflows in the year after the 2007 ABCP crisis, even as the broader financial crisis expanded, likely because sponsor support for MMFs had preserved their moneyness while other assets and cash-like vehicles were losing value.... However, when Lehman Brothers failed on September 15, 2008, some prime MMFs were holding its debt, and investors redeemed more than $300 billion (15% of assets) from prime funds in the next five days. Outflows only abated when the U.S. Treasury guaranteed virtually the entire MMF industry and the Federal Reserve provided liquidity using its emergency powers."
The NY Fed paper comments, "The 2008 run in the United States underscored the vulnerabilities of MMFs, such as the fragility of their NQA moneyness and their susceptibility to contagion. SEC data show that 29 MMFs had losses large enough to break the buck in 2008, but sponsors bailed them out.... However, the failure of just one MMF sponsor to support its fund immediately accelerated the run on the entire MMF sector. Daily prime MMF outflows on the two days after Lehman's bankruptcy (September 15 and 16) averaged $40 billion, but news late on September 16 that the Reserve Primary Fund would not be supported by its sponsor and had broken the buck prompted $102 billion in redemptions from other MMFs the next day."
It adds, "Amidst the run, the importance of liquidity transformation, the first-mover advantage for redeeming investors, and threshold effects were also clear. Investors who redeemed from the Reserve Primary Fund early on September 15 received $1 per share. But redemptions depleted the fund's liquidity, including its capacity for overdrafts from its custodian bank, and the fund halted redemptions (permanently) later that day. Investors who waited to redeem not only received less than $1 for their shares, but also had to wait several years to receive all of their money.... Institutional investors worsened stress for MMFs in 2008. Institutional MMFs, which held 64% of the assets in prime funds on the eve of Lehman's failure, accounted for 95% of the redemptions in the first five days of the run."
The paper states, "The run on prime MMFs quickly exacerbated strains in short-term funding markets, in part because MMFs had to liquidate holdings to meet redemptions. The repercussions were not limited to the United States. U.S. prime MMFs had become very large suppliers of short-term dollar funding for global banks particularly those in Europe. The run quickly put funding pressure on those banks that was only relieved by emergency increases in currency swap lines by Federal Reserve and other central banks."
It tells us, "The SEC responded to the 2008 run by adopting two sets of reforms. In 2010, it introduced daily liquid asset and WLA requirements. In 2014, the SEC mandated that all non-government funds (that is, prime and tax-exempt funds) have the ability to impose gates and fees on redemptions if their WLAs fall below the regulatory minimum of 30% of total assets. In addition, institutional prime and institutional tax-exempt funds were required to have floating (variable) NAVs. One consequence of the 2014 reforms was significant shrinkage of both the prime and tax-exempt MMF sectors in the year leading up to October 2016, when the reforms went fully into effect. Prime and tax-exempt MMF assets under management fell 68% and 47%, respectively, in that year. The assets of publicly-sold institutional prime funds fell especially sharply – 88% that year – so the fraction of prime funds held by institutional investors plummeted."
They also discuss the European debt crisis in 2011, and issues in China in 2013 and South Africa in 2014. Then they tell us, "As concerns mounted in March about the economic and financial consequences of the COVID-19 pandemic, a 'dash for cash' caused stress in a range of markets, including those for U.S. Treasury securities, corporate and municipal bonds, and money-market instruments. Redemptions from prime MMFs grew quickly into a run in mid-March.... Publicly-offered institutional prime MMFs had outflows of 30% of assets over the two-week period from March 10 to 24, and retail prime funds had outflows of 9% over a two-week interval beginning a day later.... By these measures, prime MMF outflows exceeded those in September 2008 (however, in dollar terms, institutional prime fund outflows were larger in 2008)."
Finally, they add, "MMF vulnerabilities were evident again in this crisis. The funds were susceptible to the surge in liquidity demand because of their liquidity transformation: They offered shareholders liquidity on demand at no charge even as liquidity in the markets for the instruments the funds held was becoming scarce and costly. This contributed to a first-mover advantage for redeeming investors, which was exacerbated by threshold effects, as investors redeemed on concern that funds could impose fees or gates if their WLAs fell below the 30% minimum requirement.... The first-mover advantage was clear: Funds' declining WLA levels were publicly available on a daily basis, so investors could see the detrimental effects of others’ earlier redemptions on their own prospects. `The fragility of moneyness was also a contributing factor, as the dash for cash was not indiscriminate: Investors, apparently questioning the safety of prime MMFs, redeemed from prime funds and shifted money into government funds. Institutional investors were again faster to redeem than retail investors, and funds that appear to have been held by large institutional investors experienced disproportionately larger outflows.... Like other crises, the 2020 MMF runs and strains in the United States and Europe have led to calls for further reforms and restrictions on MMF operations."
