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Discussion Paper
The Minimum Balance at Risk: A Proposal to Stabilize Money Market Funds
In a June post, we explained why the design of money market funds (MMFs) makes them prone to runs and thereby contributes to financial instability. Today, we outline a proposal for strengthening MMFs that we?ve put forward in a recent New York Fed staff report. The proposal aims to reduce, and possibly eliminate, the incentive for investors to run from a troubled fund, while retaining the defining features of money market funds that make them popular financial products. U.S. Treasury Secretary Timothy Geithner, in a recent letter to the Financial Stability Oversight Council, requested that it ...
Report
The fragility of short-term secured funding markets
This paper develops a model of financial institutions that borrow short term and invest in long-term assets that can be traded in frictionless markets. Because these financial intermediaries perform maturity transformation, they are subject to potential runs. We derive distinct liquidity, collateral, and asset liquidation constraints, which determine whether a run can occur as a result of changing market expectations. We show that the extent to which borrowers can ward off an individual run depends on whether it has sufficient liquidity, collateral, and asset liquidation capacity. These ...
Report
Repo runs
The recent financial crisis has shown that short-term collateralized borrowing may be highly unstable in times of stress. The present paper develops a dynamic equilibrium model and shows that this instability can be a consequence of market-wide changes in expectations, but does not have to be. We derive a liquidity constraint and a collateral constraint that determine whether such expectations-driven runs are possible and show that they depend crucially on the microstructure of particular funding markets that we examine in detail. In particular, our model provides insights into the ...
Report
Gates, fees, and preemptive runs
We build a model of a financial intermediary, in the tradition of Diamond and Dybvig (1983), and show that allowing the intermediary to impose redemption fees or gates in a crisis?a form of suspension of convertibility?can lead to preemptive runs. In our model, a fraction of investors (depositors) can become informed in advance about a shock to the return on the intermediary?s assets. Later, the informed investors learn the realization of the shock and choose their redemption behavior based on this information. We prove two results: First, there are situations in which informed investors ...
Report
The minimum balance at risk: a proposal to mitigate the systemic risks posed by money market funds
This paper introduces a proposal for money market fund (MMF) reform that could mitigate systemic risks arising from these funds by protecting shareholders, such as retail investors, who do not redeem quickly from distressed funds. Our proposal would require that a small fraction of each MMF investor's recent balances, called the "minimum balance at risk" (MBR), be demarcated to absorb losses if the fund is liquidated. Most regular transactions in the fund would be unaffected, but redemptions of the MBR would be delayed for thirty days. A key feature of the proposal is that large redemptions ...
Working Paper
Gates, Fees, and Preemptive Runs
We build a model of a financial intermediary, in the tradition of Diamond and Dybvig (1983), and show that allowing the intermediary to impose redemption fees or gates in a crisis--a form of suspension of convertibility--can lead to preemptive runs. In our model, a fraction of investors (depositors) can become informed about a shock to the return of the intermediary's assets. Later, the informed investors learn the realization of the shock and can choose their redemption behavior based on this information. We prove two results: First, there are situations in which informed investors would ...
Working Paper
Collateral Runs
This paper models an unexplored source of liquidity risk faced by large broker-dealers: collateral runs. By setting different contracting terms on repurchase agreements with cash borrowers and lenders, dealers can source funds for their own activities. Cash borrowers internalize the risk of losing their collateral in case their dealer defaults, prompting them to withdraw it. This incentive creates strategic complementarities for counterparties to withdraw their collateral, reducing a dealer's liquidity position and compromising her solvency. Collateral runs are markedly different than ...