U.S. Prime Money Market Funds after Lehman : The Quest to Regain Safe-Asset-Status

The behavior of MMFs since fall 2008 suggests that in evaluating the systemic risk posed by prime MMFs it is not enough to focus on the funds' ability to meet large investor withdrawals during severe stress periods. Instead, today it appears to be even more important to look at the tendency of MMFs to drastically cut exposure to suspicious borrowers at the first signs of trouble. In this sense, money funds may run first in order to either preempt or slow down runs on themselves. The paper argues that this behavior by MMFs can be explained by their quest to regain their status as a safe asset which they enjoyed prior to September 2008 and lost subsequently. The loss of "safe asset status" can certainly be attributed to key events during fall 2008 such as the "breaking of the buck" by the Reserve Primary Fund. However, the paper stresses the importance of other factors at play. In particular, it is argued that the rules and regulations governing MMFs and safe asset alternatives such as bank deposits changed notably during the last couple of years and in a way that weakened the sector's competitive position. If policymakers want to preserve the significance of prime MMFs, while increasing their stability as a funding tool, it might be necessary to weaken the position of alternative, cash equivalent safe assets. However, it is unclear what the overall benefit to financial stability of such an approach would be