Why Are Prime Money Market Funds Still So Problematic?
Here we go again. As if Covid-19 hadn’t given us all enough to worry about, in March it precipitated a short-lived run on prime money market funds. By the end of the month, approximately $100 billion had drained from institutional prime money market funds—more than 30% of their total assets. For a minute, the 2008 financial crisis seemed like just yesterday.
This time, guardrails established by post-2008 SEC reforms along with some timely backstopping by the Fed and Treasury rapidly restored stability to the market. But the scare highlighted our ongoing concerns about the role of prime money market funds as liquidity vehicles for corporate cash.
Our July research report—Liquidity in Question: What Do We Do With Prime Money Market Funds?—examines the challenges that prime money market funds continue to pose. And, it draws two important conclusions: First, corporate cash managers need to rethink how, when, and why they utilize prime money market funds in their cash investment portfolios, especially for managing day-to-day liquidity. And second, regulators have more work to do if they want to avoid resorting to emergency measures to stabilize money funds during future times of economic stress.
Following the 2008 fiscal crisis, the SEC imposed floating net asset values in prime money market funds, ending guaranteed dollar-in, dollar-out liquidity, and also established liquidity fees and redemption gates in times of economic stress. The reforms made prime funds safer but fundamentally changed their nature and utility.
Many cash investors continued to use post-reform prime funds as liquidity vehicles, which worked well enough during a decade of economic stability when the imposition of liquidity fees and redemption gates seemed a remote possibility. But the March run was a wake-up call that made the risks inherent in post-reform prime money market funds all too apparent. Our research report explains these risks in detail and cautions that prime funds, while still potentially a vehicle to add more investment income to a cash portfolio, should be used sparingly, if at all, for cash liquidity.
We also discuss how regulators might further reduce risks inherent in today’s prime money market funds. Among other things, we examine new shareholder disclosure and concentration limits, formalized contingent liquidity facilities from the Fed, and possible private joint liquidity arrangements to balance reserves industrywide. We have some experience in this area—in fact, in 2011, Capital Advisors Group Research Director Lance Pan, author of this month’s report, was invited to participate in an SEC roundtable where he discussed ways to strengthen and stabilize the money market fund industry.
This isn’t the first time we warned that another shoe might drop in the evolving market for prime money market funds. We argued a little over a year ago that reforms to prime funds in recent years require treasury professionals to adopt an entirely new cash management mindset. This month’s research report explains why, with a deep dive into the risks that are still inherent in prime funds, how they might be mitigated, and ways to think about repositioning them in your institutional cash portfolio.