Brian Byrne

FIN 320

11/6/2013

Discussion Of Money Market Mutual Funds

The economy of the United States of America allows individuals to invest their money in
an attempt to receive profitable returns. A highly liquid yet high quality investment was needed,
so in 1971, Bruce R. Brent and Henry B. R. Brown created first money market mutual fund (
MMMF). This fund was named the Reserve Fund and offered investors the opportunity to
preserve their cash, and receive a small rate of return. In more recent times, MMMFs have been
seen as just as safe as bank-insured investments, yet more profitable. The unique, special thing
about MMMFs is that they seek to never lose money. They accomplish this by maintaining a
stable rate of one dollar per share. If it ever were to fall below that value, it is known as breaking
the buck. Prior to the 2008 bankruptcy of Lehman Brothers Holdings Inc., a case where the buck
was broken only occurred three other times, and each one averted by an influx of money from
the fund sponsors. The Lehman Brothers bankruptcy was a serious crisis that started a major run
on MMMFs and even threatened a mismatch in maturities. In the shadow of this crisis
reminiscent of the Depression Era, the Securities and Exchange Commission proposed several
reforms to increase the stability of MMMFs. These reforms are ultimately necessary to ensure
the continued economic prosperity of America.
The world of investments can be myriad and complex at best. For a new investor
considering his options, he will eventually come across MMMFs and FDIC insured deposits. To
the untrained eye, these two may seem very similar, very different, or just plain confusing. The
truth is, they share some similarities but also differ from each other. Unlike the FDIC insured
fund, the MMMF is an open-ended mutual fund that pools money from various investors to buy
securities. The investor can choose to buy or sell at any point. The MMMFs invest in short term
securities, such as a U.S. treasury bill. These short term debt securities entitle the holder of the
security to only its principal and its corresponding interest. In addition, they are only secured by
collateral, or not at all. This frighten some investors in that they can never be in hundred percent
sure that their investments will be safe. Some debt securities do have seniority in the debt, or
some debt securities will be lost before others based on the time that they were held. The FDIC
insured deposits are insured up to 250,000 dollars. The MMMFs are still regulated under the
Investment Commerce Act of 1940, while the FDIC was established in 1934. So the FDIC does
have more of a reputation. Indeed Since the start of FDIC insurance on January 1, 1934, no
depositor has lost a single cent of insured funds as a result of a failure (Miles). Any institution
with that sort of record is bound to attract investors. Finally, the MMMFs are seen as very liquid
to financial intermediaries. They have the ability to be traded with causing significant movement
in price.
The 2008 bankruptcy of the Lehman Brothers Holdings Inc. was a serious blow to the
market and reputation of MMMFs. The Bank of New York Mellon and the Reserve Primary
Fund both dropped below one dollar per share, breaking the dollar. The first time in history that
the such an event had occurred. The SEC could not do much, in that month. According to
Andrew Sorkin, since the collapse happened before the passage of the Trouble Asset Relief
Program (TARP), the Treasury Department had no legal authority to put government money into
the Lehman Brothers firm or provide a guarantee for its obligations. Effectively, the
governments hands were tied in many cases because the plight of the Lehman Brothers did not
occur at the right time or did not fit the bill for relief aid. Furthermore, the Treasury Department
did possess a sort of stabilization fund. It is essentially a pool of money that is set aside for
efforts to eliminate any threat that may be made against the dollar. Unfortunately for the Lehman
Brothers, their plight was not seen as a threat to the dollar, so they were not granted any relief
from the stabilization fund. The actions of the Treasury Department concerning the Lehman
Brothers would not necessarily have an effect on moral hazard, except to set a precedent for
when it should be undertaken. In moral hazard, one party takes a risk because it knows that the
other party will take the consequences for the actions. However, since the Treasury Department
knew that it would be taking the fall, it made the logical move to not take the risk.
In the wake of the crisis in September of 2008, the Securities and Exchange Commission
knew that some changes had to be made to MMMFs in order to increase their stability and
prevent any further crises from occurring. One of the main proposed alternatives to the current
system was the floating of the Net Asset Value (NAV). This would entail that the MMMF would
process purchases on current market based values. This will limit the funds to short-term yet high
quality dollar denominated instruments that make MMMFs unique. This action will attract
investors seeking a higher yield during periodic episodes of economic instability that naturally
occur in Americas free market economy. According to Eric Rosengren, a way to attract
investors and reduce the likelihood of them redeeming in times of stress is to create new more
prevalent disclosures. Therefore, MMMFs would be obligated to release the current and
historical sponsored support as well as daily liquid assets. To ensure maximum, availability to
the investors, the MMMFs could even go as far as to disclose the weekly or daily portfolio
holdings so investors can know the standings and any point. They will not have to guess at the
action of the markets or other investors and in knowledge there is safety and security of mind
and wallet. Another reform that would go a long way in preventing another crisis to require five
percent diversification of sponsors. The issue is that with current requirements, investor
concentration can become a problem. In some cases, Rosengren found that the largest five
shareholders each had at least five percent stake in the fund. So essentially if one or two redeem
suddenly, then the fund will breach the WLA threshold. This in turn may cause other investors
who perceive that their funds are similar to the ones that redeemed, will quickly redeem out of
fear and possibly cause a run. The proposed reform to increase investor stability and therefore
the stability of the funds overall is to establish stand-by liquidity fees and temporary redemption
gates. Otherwise there is no real way to solve financial stability. Investors may see that they
should redeem before the fund breaches the WLA threshold. Investors cannot know how other
investors will react in a run so they panic and think that the safest viable option is to redeem
before everyone else. This creates a mob mentality of sorts of who can redeem the fastest. This
situation will inevitably cause a run and possibly lead to more serious situations.
The solutions to the stability problems that arose out of the 2008 Lehman Brothers
Holding Inc. are many and varied, yet each is designed to increase the stability of the MMMFs
directly or increase the confidence of the investor and therefore of the MMMF as a whole.
William Birdthistle brings up the point that the reform may affect the cash management of the
MMMFs through floating NAV and liquidity restrictions, but one must consider the benefits
versus the costs. All these reforms are ultimately necessary for the continued stability of
MMMFs and the economy. These crises that occur because of market instability scare investors
and the American capitalist economy needs investors to keep the economy from becoming
stagnant. All variety of investment options must be kept available for the common citizen.
Overall, since their beginning in 1971, MMMFs have functioned as a good source of a liquid
investment that is relatively safe. The only real setback was the bankruptcy of Lehman Brothers
Holdings Inc. in 2008. However, that was not a critical blow to MMMFs and they are still
operating strongly today. Indeed, the collapse might have been a good thing because now they
will be more stable and safer for the investor.

Bibliography

Baily, Martin, et al. "Reforming money market funds." (2011).

Birdthistle, William. "Breaking Bucks in Money Market Funds." Wisconsin Law Review 2010.5 (2010):
1155.

Miles, Barbara, and William Jackson. "Bank and Thrift Deposit Insurance Premiums: The Record from
1934 to 2004." CRS Report to Congress (RS21719). 2005.

Rosengren, Eric. "Our Financial StructuresAre They Prepared for Financial Instability?." Keynote
remarks at the Conference on Post-Crisis Banking, Amsterdam, The Netherlands, June. Vol. 29. 2012.

Rosengren, Eric S. "Defining financial stability, and some policy implications of applying the
definition." Keynote Remarks at the Stanford Finance Forum Graduate School of Business, Stanford
University. 2011.

Sorkin, Andrew Ross. "Lehman files for bankruptcy; Merrill is sold." The New York Times 14.09 (2008).