Once Burned, Twice Shy: Money Market Fund Responses to a Systemic Liquidity Shock

Abstract

In the immediate aftermath of the Lehman collapse, investors ran from risky money market funds. In 27 of them, outflows were large enough to overwhelm cash inflows from maturing assets, thus forcing asset sales. We find that these money funds responded by selling their safest and most liquid holdings. As a result, funds were left holding higher risk and longer maturity assets than desired. Over the subsequent quarter, however, the hard-hit funds reduced risk more than other funds, relative to their initial holdings before the crisis. In contrast, money funds hit by idiosyncratic liquidity shocks before the Lehman crisis did not alter portfolio risk. The result suggests that moral hazard concerns associated with the Treasury Guarantee of money market investor claims did not lead to increased risk taking. Rather than increase risk, funds that benefitted most from the government bailout reduced risk.