Tag Archives: Money market

Portfolio Adjustments in Money Market Mutual Funds

On the Liberty Street Economics blog,

First, institutional prime and muni funds—but not retail or government funds—must now compute their net asset values (NAVs) using market-based factors, thereby abandoning the fixed NAV that had been a hallmark of the MMF industry. Second, all prime and muni funds must adopt a system of gates and fees on redemptions, which can be imposed under certain stress scenarios.

Investors adjusted their portfolios in response to these changes:

… investors’ shift from prime and muni funds to government—and, in particular, agency—funds means that a large segment of the industry still operates under a stable NAV (and therefore is, in principle, vulnerable to runs). … Since the new regulations have resulted in a very large shift of assets into relatively safe government funds, the SEC’s reforms have made runs on MMFs less likely and the industry itself more resilient.

Pawn Shops, Information Insensitivity, and Debt-on-Debt

In a BIS working paper (January 2015), Bengt Holmstrom summarizes some of the implications of the research on information insensitive debt. He cautions against moves to increase transparency in debt markets and defends the shadow banking system. He explains why opacity and information insensitivity are valuable and argues that debt-on-debt arrangements are (privately) optimal.

It all started with pawn shops:

The beauty lies in the fact that collateralised lending obviates the need to discover the exact price of the collateral. …

Today’s repo markets … are close cousins of pawn brokering with similar risks for the parties involved. … the buyer of the asset (the lender) bears the risk that the seller (the borrower) will not have the money to repurchase the asset and just like the pawnbroker, has to sell the asset in the market instead. The seller bears the risk that the buyer of the asset may have rehypothecated (reused) the posted collateral and cannot deliver it back on the termination date. … the risk that a pawnbroker may sell or lose the pawn was a big issue in ancient times and could explain why the Chinese pawnbrokers were Buddhist monks. …

People often assume that liquidity requires transparency, but this is a misunderstanding. What is required for liquidity is symmetric information about the payoff of the security that is being traded so that adverse selection does not impair the market. …

… stock markets are in almost all respects different from money markets …: risk-sharing versus liquidity provision, price discovery versus no price discovery, information-sensitive versus insensitive, transparent versus opaque, large versus small investments in information, anonymous versus bilateral, small unit trades versus large unit trades. … money markets operate under much greater urgency than stock markets. There is generally very little to lose if one stays out of the stock market for a day or longer. This is one reason the volume of trade is very volatile in stock markets. In money markets the volume of trade is very stable, because it could be disastrous if, for instance, overnight debt would not be rolled over each day. …

… debt-on-debt is optimal … . It is optimal to buy debt as collateral to insure against liquidity shocks tomorrow and it is optimal to issue debt against that collateral tomorrow. In fact, repeating the process over time is optimal, too, so debt is in a very robust sense the best possible collateral. This provides a strong reason for using debt as collateral in the shadow banking system. …

Panics always involve debt. Panics happen when information insensitive debt (or banks) turns into information-sensitive debt.