Mitigating Risk in Retail Prime Money Market Funds: Capital Buffer Sizing and Pricing
Open AccessMoney market funds are investment vehicles that purchase short-term debt instruments issued by financial and non-financial corporations, state and local governments, and government entities. Money market funds are important to the financial system as they provide as an alternative to short-term bank loans for firms, and as deposit accounts for investors. During the 2008 financial crisis the Reserve Primary Fund failed, and the U.S. Treasury responded with unprecedented guarantees, thereby putting taxpayer dollars at risk. Post-crisis, the Securities and Exchange Commission instituted reforms for U.S. money market funds.The purpose of this research is to shed light on mitigating risk in U.S. retail prime money market funds. We believe that the post crisis reforms instituted by the Securities and Exchange Commission are inadequate and that future bouts of financial stress will result in fund failures or additional rounds of government led support. Through the use of stochastic simulation this work shows that the post crisis reforms are insufficient and do not adequately protect against future retail prime money market fund failures. This work suggests loss-absorbing capital as a viable mechanism to enhance the resiliency of U.S. retail prime money market funds. The proposed capital buffer is coupled with an orderly wind-down mechanism that alleviates the destabilizing nature of fund failures.
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