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1 1 (September 26, 2019)

handle is hein.crs/govbbeo0001 and id is 1 raw text is: norrnngin tleearch 1914 S September 26, 2019 Money Market Mutual Funds: A Financial Stability Case Study A money market mutual fund (MMF) is a mutual fund that under Securities and Exchange Commission (SEC) Rule 2a- 7 can invest only in high-quality, short-term debt securities, such as U.S. Treasury bills or commercial paper (a type of corporate debt). MMFs are commonly considered as safe alternatives to bank deposits, although they are not federally insured like bank deposits. However, this perceived-to-be-safe financial instrument triggered major market disruptions in 2008 that accelerated the 2007-2009 financial crisis. This case study explains the incident, the post-crisis reforms, and the ongoing policy debate. MMFs and the 2007-2009 Financial Crisis On September 15, 2008, Lehman Brothers Holdings Inc., an investment bank, filed for bankruptcy. The next day, one prominent MMF-the Reserve Primary Fund-saw its per share price fall from $1.00 to $0.97 after writing off its Lehman debt. This event triggered an array of market reactions, including investors' redemptions of more than $250 billion throughout the MMF industry within a few days of the bankruptcy. The consequences of these actions were potentially so dire to U.S. financial stability that the government ultimately intervened: * The Treasury Department provided explicit temporary deposit insurance to all MMF investors. Over its life, the program guaranteed more than $3 trillion in deposits and earned $1.2 billion in insurance coverage fees, but no guaranteed funds failed. Treasury announced this program without seeking specific congressional authorization, justifying the program on the grounds that guaranteeing MMFs would protect the value of the dollar. After the fact, Congress addressed the guarantee in the Emergency Economic Stabilization Act (P.L. 110- 343), reimbursing the exchange stability fund (ESF) that backed the guarantee, but also forbidding the future use of the ESF to provide such a guarantee. * The Federal Reserve System also established multiple emergency liquidity facilities under its statutory authority invoked by unusual and exigent circumstances in September and October of 2008 to provide a backstop to MMFs and commercial paper as part of a broader crisis response. These programs expired without loss between late 2009 and early 2010. (See CRS Report R43413, Costs of Government Interventions in Response to the Financial Crisis: A Retrospective, by Baird Webel and Marc Labonte.) Financia Stab Ity Considerations Threats to financial stability, or systemic risk, can be viewed in different ways (e.g., spillover, contagion, and negative feedback loops). They largely relate to the transmission of risks from one event to broadly affect the confidence and functioning of the financial system as a whole. MMFs pose financial stability concerns because they demonstrated during the 2008 market events that they were susceptible to sudden large redemptions (runs), causing dislocation in short-term funding markets. Share redemption is the MMF feature that is often discussed under the context of runs. Redemptions at Per Share Net Asset Value Share redemption allows MMF investors to exit their investment positions by selling their shares back to the fund on demand. Investors redeem MMF shares at per share net asset value (NAV), meaning the value of a fund's assets minus liabilities. Prior to the 2007-2009 crisis, MMFs generally maintained a stable NAV at $1.00 per share, paying dividends as their value rises, thus closely mimicking the features of a bank deposit. If its stable NAV drops below $1.00, which rarely occurs, although it occurred in 2008, it is said that the MMF broke the buck. MMFs are susceptible to runs because investors have an incentive to redeem shares before others do when there is a perception that the fund could suffer a loss. Thus when the Reserve Primary Fund broke the buck, MMF investors elsewhere also rushed to exit their positions, spreading fear that MMFs, and even the broader financial system, were vulnerable, regardless of whether actual losses occurred. Post-Crisis Reforms MMFs are regulated primarily under the Investment Company Act of 1940 (P.L. 76-768) and Rule 2a-7 pursuant to the act. To mitigate MMFs' systemic risk, the SEC reformed Rule 2a-7 in a multi-year process: February 2010-SEC adopted certain Rule 2a-7 amendments to strengthen MMF liquidity. March 2011-SEC proposed rules to eliminate certain references to credit ratings in MMF reforms. The rules were re-proposed in July 2014 and adopted in September 2015. June 2013-SEC proposed rules to convert institutional prime and institutional municipal MMFs to floating NAV. March 2014-SEC issued multiple MMF economic studies to solicit public comments. July 2014-SEC finalized the 2014 MMF reform. October 2016-SEC MMF reform became effective. The main types of MMFs are (1) municipal, also referred to as tax-exempt, which invest in national or state municipal securities that are free of national or state income tax; (2) https:I/crsreports.conc -- -q

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