Money Market Funds Can Lose Money, Just Not Your Money

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Money market mutual funds are among other things "mutual funds," meaning that they're piles of stuff owned by people called "shareholders." The shareholders ultimately own the stuff, so if you put $100 into a money market fund and it invests it in stuff and the stuff loses half its value then you should only get back $50. This is what it means to be a shareholder: you have a stake in a business, here the business of sitting around looking fondly at a pile of AAA-rated short-term debt instruments, and when that business does well you share in the rewards and when it does poorly you bear the losses.

But nobody goes around thinking of themselves as "shareholders" in the venture of money-market-fundery; rather, they think of their money market funds as basically being "cash" and when they put in $100 they expect to get back $100 and also, in some historical periods rather far removed from ours, a thing that they would call "interest," though of course "shareholders" don't get "interest."*

One tip that no one thinks of MMMF shareholders as shareholders is this post from John Carney about a "secretive government program to bail out money-market mutual funds," specifically treasury's guarantee of money market fund asset values announced in 2008, which I suppose was secretive in the narrow sense that only now and via FOIA are we learning which money market funds took advantage of it.** In the broader sense, it was not particularly secretive, as Treasury actually announced the shit out of it for the fairly obvious reason that a government guarantee cannot restore confidence in a beleaguered asset class if you do not tell anyone about it.***

Secretive or otherwise, though, it was a weird program: while you might think that the government was too solicitous or not solicitous enough of various creditors of various things during the financial crisis, this is the only place I'm aware of where shareholders in a thing were guaranteed not to lose money on their shares in that thing. But, y'know, "shareholders."

Even when the government wasn't stepping in to bless money market funds, their sponsors were: 155 money-market fund sponsors got SEC permission to pump cash into the funds to prevent shareholders from losing any money. The SEC doesn't love this fact, because it suggests that cash-pumping was necessary, and the SEC is unwilling to rely on the sponsors to pump the cash in the next crisis and are worried that that responsibility will fall to someone else.

In general the government, especially though not exclusively in the form of Mary Schapiro at the SEC, has been on a never-again-with-the-money-market-funds kick recently. Part of the problem with this kick is that when you go around saying "this massive industry where people park their cash in exchange for tiny yields and immediate liquidity and where they've basically never lost money is the place where people will LOSE ALL THE MONEY," you sound sort of like a conspiracy theorist, and people are all "you're worried about money market funds? really? that's just, like, cash, right?"

But there are serious reasons to worry about the proliferation of information-insensitive debt, and about how money market funds depend on that, so finding a non-scary way to make them more resilient seems like a good idea. I enjoyed this proposal from the New York Fed,**** to basically require money market fund shareholders to be 95% creditors and 5% shareholders:

Our proposal would require that a small fraction of each MMF investor’s recent balances, called the “minimum balance at risk” (MBR), be demarcated to absorb losses if the fund is liquidated. Most regular transactions in the fund would be unaffected, but redemptions of the MBR would be delayed for thirty days. A key feature of the proposal is that large redemptions would subordinate a portion of an investor’s MBR, creating a disincentive to redeem if the fund is likely to have losses.

The idea is that, if a fund goes kaput, the practical waterfall of who bears the losses is:

  • up to 5 cents on the dollar (the MBR) from people who got out early, then
  • up to 5 cents on the dollar from people who stuck around and tried to be supportive, then
  • the other 95 cents on the dollar from people who stuck around and tried to be supportive,***** then
  • there is no then - getting out early really does get you your 95 cents back.

This would disincentivize getting out early, also known as "runs on the bank," and since losses are in theory (whose theory?) more likely to come from illiquidity, temporary market conditions, etc., than actual losses of principal on the super-safe debt instruments that live in the money market funds, preventing runs is kind of the name of the game.

I like this first of all because it's baby steps: to adopt this, you don't need to persuade investors that the entirety of their "cash" in money markets is an equity investment in a pool of debt securities selected by fallible humans from among a universe of such securities given prime ratings by even more fallible humans, or that when things go wrong in that pool the first loss is theirs. Instead, you reach a bargain with investors: if you want to think about this stuff as super-safe, that's great, it probably will be. Because your money will be protected by a subordination cushion, and that cushion will come from the other jerks who aren't so trusting. Those jerks, meanwhile, will have more incentive to monitor early and often.

More generally, treating money-market investors - who conceive of themselves basically as super-senior fixed-income claimants - as 95% super-senior fixed-income and 5% equity-ish is a clever idea. This is in part because they really are shareholders: they're the residual claimants on the success of their money-market venture, so it's reasonable to reward shareholders who take one for the team ahead of those who try to cash out at the first sign of liquidity problems. But the anti-run-incentives arguments apply elsewhere, too, and you might think about applying variations on this theme to other kinds of debt to prevent other kinds of bank runs, whether in repo or, um, banks.

Treasury's Secretive $2.4 Trillion Mutual Fund Guarantee [NetNet]
SEC List Shows 155 Money Funds That Got Approval for Help [Bloomberg]
The Minimum Balance at Risk: A Proposal to Mitigate the Systemic Risks Posed by Money Market Funds [FRBNY]

* Shareholders get dividends; interest is what you get from leaving your cash alone for long enough (and in a higher interest-rate state of the world), and this isn't cash: it's shares.

** Amusingly: 99% of them. Was this the wrong call? If you were in the 1%, did investors just assume that you'd gone along with everyone else and paid the 4bps fee for a guarantee and stay with you, so you got the benefit of the much publicized guarantee without the cost?

*** UNTRUE.

**** Which seems to be dated July 19, but showed up in my RSS today. New to me!

***** I mean, there is no conceptual difference between this and the preceding bullet. In the proposal there is, though, because you could have only partial subordination of the buffer.

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Banks Prove That They Are Not Too Big To Fail By Saying "We Can Fail" On A Piece Of Paper, Moving On

One way you could spend this slow week is reading the "living wills" submitted by a bunch of banks telling regulators how to wind them up if they go under. Don't, though: they're about the most boring and least informative things imaginable and I am angry that I read them.* Here for instance is how JPMorgan would wind itself up if left to its own devices**: (1) It would just file for bankruptcy and stiff its non-deposit creditors (at the holding company and then, if necessary, at the bank). (2) If after stiffing its non-deposit creditors it didn't have enough money to pay its depositors it would sell its highly attractive businesses in a competitive sale to willing buyers who would pay top dollar. This seems wrong, no? And not just in the sense of "in my opinion that would be sort of difficult, what with people freaking out about JPMorgan going bankrupt and its highly attractive businesses having landing it in, um, bankruptcy." It's wrong in the sense that it's the opposite of having a plan for dealing with banks being "too big to fail": it's premised on an assumption that the bank is not too big to fail. If JPMorgan runs into trouble that it can't get out of without taxpayer support, it'll just file for bankruptcy like anybody else. Depositors will be repaid (if they're under FDIC limits); non-depositor creditors will be screwed just like they would be on a failure of Second Community Bank of Kenosha.