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Unpublished Paper
Untangling the MMF Problem: A Public-Private Liquidity Fund Proposal
Stanford Journal of Law, Business and Finance (2013)
  • Jonathan W Lim, Harvard Law School
Money Market Mutual Funds (MMFs) have developed in the last 40 years as a vital part of the U.S. financial system. Yet, the problem of MMF structural reform remains unsolved almost five years on from the 2008 financial crisis. I hypothesize that its seeming intractability is not just political, but also conceptual: the available reform proposals are not theoretically satisfying. This paper develops a three-part framework to assess the efficacy of existing reform proposals, in the hope of pointing to new directions. First, I analyze the structural susceptibility of MMFs to “runs”, as well their role as a vector for systemic risk via contagion. Concluding that MMF run-fragility and their contagion risks derive from maturity mismatch coupled with the behavioral dynamics of short-term investors, I argue for the necessity of public support measures for effective reform. Second, any MMF regulation must aim to avoid or limit moral hazard, especially if public support is necessary. I argue that this should be done by internalizing systemic risk costs through ex-ante private payments that are risk-assessed. Third, I argue that MMF structural reform must take into account meaningful differences between such funds and bank deposits. To the extent MMFs play a conceptually distinct role in the modern financial system that cannot be perfectly substituted by bank deposits, modifying the structural attributes of MMFs that compromise its ability to perform that role would have unintended economic costs and real migration risks. Applying this framework, I next show how recent proposals by the FSOC and IOSCO are fundamentally flawed because they do not address the structural weakness that derives from maturity mismatch, and cannot effectively prevent runs of the scale experienced in 2008. On the other hand, alternative proposals such as deposit-style insurance and “narrow purpose banks” address the run and contagion problems, but have considerable difficulty mitigating moral hazard costs and migration risk. Given the limits of the available options, I make a unique proposal for a Public-Private Liquidity Fund (PPLF) as an optimal mode of reform.
Publication Date
Fall 2013
Citation Information
Jonathan W Lim. "Untangling the MMF Problem: A Public-Private Liquidity Fund Proposal" Stanford Journal of Law, Business and Finance (2013)
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