The Investment Company Institute ("ICI") COVID-19 Market Impact Working Group examined the performance of money market funds during the period of volatility following the start of the COVID-19 pandemic.
In its report, the ICI found that money market funds performed better during the COVID-19 pandemic than they had during the 2007-2009 financial crisis, in part because of SEC restrictions on money market funds that had limited the authority of such funds to hold risky assets or assets with a longer maturity. ICI noted that the SEC's rule changes had driven many investors from money market funds that invest in corporate debt to those that invest only in government securities. The ICI asserted that, in light of the improvements in money market performance, the stresses within the financial markets - particularly short-term credit markets - were not precipitated by prime money market funds.
The ICI also found that one aspect of the 2014 rule changes may have made institutional prime money market funds less resilient: the authority of money market funds to impose a liquidity gate if their weekly liquid assets dropped below 30%. The ICI suggested that a breach by a fund of the 30% liquidity level was thereafter viewed by institutional investors as a reason to withdraw all assets from the fund, which became a cause of destabilization.
ICI also raised the question of whether bank capital requirements had contributed to the liquidity crisis in the early stages of the pandemic. ICI noted, that "ironically, the stringent regulatory capital requirements under which banks must now operate . . . make it more costly for [banks] . . . to take securities into their inventories."
Additionally, the ICI highlighted efforts from federal regulators to enhance liquidity provisions and improve the flow of credit. The ICI observed that "during both the global financial crisis and the COVID-19 crisis, outflows from institutional prime money market funds ceased, or diminished sharply, once the federal government intervened."
Commentary
There have now been a number of studies of, or reactions to, the mini-financial crisis caused by the pandemic. See, e.g., the FIA study on the effects of CCP demands for more margin; the statement of FRB Vice Chair Randal Quarles on the "dash for cash"; and the SEC Report on U.S. Credit Market Performance. BlackRock has also published a number of studies on the pandemic, including one on U.S. Short Term Money Markets.
Some common threads run through all of these studies: they all find that the financial markets performed better during the pandemic crisis than during the earlier financial crisis, and they all attribute this in good part to some of the changes in financial regulation made as a result of the crisis. They also all note that things would have gotten worse had it not been for the various forms of government intervention. Worth noting is that government intervention during the financial crisis was largely through financial institution interventions, and, in the pandemic crisis, much of the government intervention was to businesses and individuals.
The various studies show how difficult it is to genuinely improve liquidity. Liquidity requirements have the potential to be a zero-sum game, particularly if the requirement to be liquid means a requirement to hold cash or government securities. In that case, demanding a party turn its non-governmental assets into cash makes another party - the issuer of those assets - more vulnerable. Liquidity may even be worse than a zero-sum game in certain cases, as demonstrated by the ability of the derivatives clearing corporations to call for tremendous amounts of initial margin from their participants, thereby draining tremendous liquidity from the market.
Primary Sources
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