The Federal Reserve Bank of Richmond published an article entitled, "Some Theoretical Considerations Regarding Net Asset Values for Money Market Funds" in its latest "Economic Quarterly." The article, by Huberto M. Ennis, comments in its summary, "The instability of money market mutual funds is a subject of active debate. A new regulatory framework is likely to be implemented soon in the United States. The design of such a framework should depend on an assessment of which is the main economic function fulfilled by these funds. If money funds are providing maturity transformation, then redemption values that permanently reflect the market value of assets may be hard to compute and may undermine the purpose of the funds. If funds are mainly investment managers, then market-based redemption values can be appropriate and increase the stability of the funds."
A press release, entitled, "Richmond Fed's Economic Quarterly Considers Net Asset Values for Money Market Funds," tells us, "The instability of money market mutual funds is a subject of active debate. In the latest issue of Economic Quarterly, Richmond Fed economist Huberto M. Ennis explores a new regulatory framework that is likely to be implemented soon in the United States. The design of such a framework should depend on an assessment of which is the main economic function fulfilled by these funds. If money funds are providing maturity transformation, then redemption values that permanently reflect the market value of assets may be hard to compute and may undermine the purpose of the funds. If funds are mainly investment managers, then market-based redemption values can be appropriate and increase the stability of the funds. You can find the full text of this article and others in the latest issue of Economic Quarterly on our website: www.richmondfed.org/publications/research/economic_quarterly/."
The paper's "Conclusion" says, "Money market funds experienced considerable distress in 2008 during the U.S. financial crisis. Their resiliency was questioned again in 2011 during the European sovereign crisis (see Chernenko and Sunderam [2012] and Rosengren [2012]). Currently, a generalized concern exists that the instability of money funds may have systemic consequences (Financial Stability Oversight Council 2012). For these reasons, there is a heated ongoing debate about the appropriate reform of the regulatory framework that applies to these funds."
It explains, "In this article, we have presented two models that represent, in a stylized manner, two possible alternative interpretations of the economic function fulfilled by money funds. In both models, money funds may experience waves of withdrawals that resemble runs. The frameworks, however, are not flexible enough to address systemic concerns such as contagion and economy-wide disruptions triggered by the troubles in the money funds industry. Still, some important insights about fund stability and regulation arise from the analysis. One of the main lessons of the article is that the appropriate regulation of money market funds depends on the stand taken with respect to the fundamental economic function performed by the funds."
Ennis writes, "In particular, if money funds are mainly providers of maturity transformation services, then the setting of the redemption value of shares needs to take into account the optimal insurance component involved in this kind of arrangement. Extreme versions of floating net asset values may undermine this function, just as narrow banking tends to undermine the maturity transformation function of banks. Perhaps some instability is inextricably associated with maturity transformation, and trying to completely rule out instability translates into ruling out any degree of maturity transformation. Under this view, stable money funds can, in effect, be redundant institutions."
Finally, he adds, "However, in the second model we presented in this article, we took on the interpretation that money funds are instead investment managers that are able to access, select, and implement beneficial asset-allocation strategies for their investors. Under this view, money funds do not perform any maturity transformation. We learned that in this case a timely adjustment of the funds redemption value of shares (such as a floating NAV) may be conducive to stability and is compatible with the funds intended function. To a certain extent, then, alternative reform-proposals involving NAVs indirectly reflect different perspectives about the main function that money funds perform in the economy."
