Money Market Funds, Bank Runs and the First Mover Advantage

Abstract

Several recent reports from regulatory bodies have recommended that money market funds should be required to move from stable to variable net asset valuation pricing, to reduce the risk of first-mover advantage and the risk of a run on the fund. Most money market fund sponsors doubt that this proposal will reduce either run risk or first-mover advantage. Thirty years of academic research on bank runs has concluded that the best protections against bank runs are retail deposit insurance or the suspension of convertibility. There are no arguments within the academic literature in favour of changing the terms of the demand deposit contract, from stable to variable value: it is quite remarkable that the preferred solution for MMFs is one without precedent in banking regulation. Money market funds are different from banks in four fundamental respects. These differences concern their legal form but also, importantly, their economic function. Money market funds do not engage in fractional reserve banking and they do not perform liquidity creation. Money market funds, like other capital markets products, are vulnerable to the unanticipated actions of investors during periods of market distress. At such moments there is a risk that money market funds might contribute to the amplification of systemic risk. In a period of heightened systemic risk, the ability of money market funds to suspend the standard terms under which shareholders are able to redeem fund units for cash, is the mechanism most likely to eradicate the possibility of a first mover advantage and thereby to reduce the risk of a run. In the absence of a credible deposit insurance policy for the money market fund industry, suspension of convertibility should be the preferred option: for regulators, for fund sponsors and for investors.