The 2008 money market crisis

The 2008 financial crisis triggered a money market crisis that included the failure of the original and oldest U.S. money fund, the $62 billion Reserve Primary Fund, which broke the one dollar net asset value mark (known as breaking the buck) in September 2008. An ensuing net redemption of prime money market funds by both institutional and retail investors was counterbalanced by an inflow of funds to treasury/government money funds. Government action during the crisis included the formation of emergency measures designed to support and stabilize money markets. Subsequently, money market fund reform measures were instituted in 2010, with a second round of reforms added in 2014.

Historical background
In August 2007, widening spreads in the commercial paper market, combined with mortgage security losses, resulted in the default of several structured investment vehicles. These defaults included Cheyne Finance and Axon SIV. Additional problems with subprime mortgages surfaced in August as two Bear Stearns’s hedge funds filed for bankruptcy, and a third Bear Stearns’s hedge fund suspended investors’ redemptions. On August 7, 2007 the French bank BNP Paribas halted withdrawals from its three investment funds and suspended calculation of their net asset values. These actions resulted in lower demand for asset-backed commercial paper and a movement of institutional money from unregulated liquidity pools to money market funds. Financial difficulties continued into the spring of 2008, with the failure of auctions for auction-rate securities. In March 2008, Bear Stearns, a global investment bank and securities trading and brokerage firm, became insolvent. Intervention by the Federal Reserve, first with a bridge loan to the firm, and then with an arranged merger/acquisition of the firm by JPMorgan Chase and Co. managed to avoid outright bankruptcy.

The 2008 financial crisis reached its climax during the month of September (see accompanying table for a timeline of September events).

On September 7, the large U.S. mortgage Government Sponsored Enterprises, Fannie Mae and Freddie Mac, were declared insolvent and placed in conservatorship. On September 14, the Bank of America bought the insolvent Merrill Lynch brokerage. On September 15, Lehmann Brothers, a global financial services firm, declared bankruptcy. Investors began selling prime money market funds on Friday, September 12, and continued selling them on Monday, September 15.

On Tuesday, September 16, the Reserve Primary Fund, holding $785 million of defaulted Lehmann Brothers commercial paper, announced that, due to the default, the net asset value of the money fund had broken the 1.00 net asset value mark and was now valued at 0.97. Over the next four days investors withdrew $23 billion and made redemption requests of $60 billion from the $62 billion dollar fund. In addition, a number of money funds received sponsor support, by means of either capital infusion or purchase of discounted paper at book value, during this period.

During the calendar week of the crisis institutional prime funds had large net outflow every day while retail prime funds had net outflow Wednesday through Friday. Institutional government and retail government funds received large daily net inflow during this period. Over the 9/2/2008 to 10/7/ 2008 time frame, government money market fund assets increased by $409 billion (44 percent) as prime fund assets fell by $498 billion (24 percent).

At this point, the market for commercial paper became illiquid. Issuers generally issued, and buyers generally were only willing to buy, overnight issues of commercial paper. Longer maturities did not trade.

On September 19, the U.S. Treasury announced the establishment of a temporary guarantee program to protect shareholders of money market mutual funds. Three additional programs were initiated in September and October: Further details on the programs are available at:
 * Money Market Investor Funding Facility (MMIFF)
 * Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility (AMLF)
 * Commercial Paper Funding Facility (CPFF). Each program had a specific purpose and a finite life span:
 *  Treasury Guarantee Program for Money Market Funds provided insurance for investor money fund accounts. The program was initially in effect for three months, beginning September 19, 2008, but was later extended through September 18, 2009. Treasury did not extend the program beyond September 18, 2009.
 * Money Market Investor Funding Facility (MMIFF) provided liquidity to U.S. money market mutual funds in order to increase their ability to meet redemption requests and to enhance money market investors' willingness to invest in money market instruments, particularly for terms longer than overnight. The facility was announced on October 21, 2008, and was closed on October 30, 2009.
 * Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility (AMLF) provided liquidity that allowed money funds to sell asset-backed commercial paper. The facility was announced on September 19, 2008, and was closed on February 1, 2010.
 * Commercial Paper Funding Facility (CPFF) allowed the Federal Reserve to directly purchase commercial paper, providing liquidity to the market. The facility was announced on October 7, 2008, began purchases of commercial paper on October 27, 2008, and was closed on February 1, 2010.
 * Treasury’s Temporary Guarantee Program for Money Market Funds
 * Money Market Investor Funding Facility (MMIFF)
 * Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility (AMLF)
 * Commercial Paper Funding Facility (CPFF)

The programs were aimed at increasing liquidity within the commercial paper market. The intervention moves succeeded in halting the run on prime money fund assets, and unlocked the commercial paper market.

Explanations for money fund redemption


The September 2008 run on prime money market funds (see figure to the right for a chart of prime money fund asset levels over the period; click table to enlarge) has led investors, academics and financial market regulators to seek plausible explanations for investor conduct. The most commonly cited investor motivations include investor flights to quality; flights to liquidity; flights to transparency; and flights to performance.

During the crisis period, investors shifted from money funds that held securities subject to default to treasury/government funds that possess low default risk. Both Wermers (2012) and McCabe (2010) also point out that investors shifted funds to prime funds that were judged capable of providing sponsor support if needed. (See table three in figure to the right; note that of 116 institutional prime money funds, ten saw assets shrink by more than 50 percent during this period and another twelve lost between 40 and 50 percent of assets, but 20 had net inflows over the same period.)
 * Flight to quality.

Institutional investors demand having immediate access to their cash holdings. The most liquid money market securities are treasury bills and other government securities. The shift to treasury/government funds during the crisis is an indication of investor preference for liquidity.
 * Flight to liquidity.

With the risk of default rising, investors sought funds with the highest levels of portfolio transparency. Since treasury/government funds, by prospectus policy, hold at least 80% of the portfolio in treasury securities, they offer reliable transparency. The crisis also encouraged prime money market managers to release current information on fund holdings and issue statements to investors.
 * Flight to transparency.

The SEC's RSFI cite academic research that provides evidence that higher performance attracts additional flows.
 * Flight to performance.

The 2010 money market fund reforms
The 2008 money market crisis provided an impetus to both industry and regulators to produce reform measures. On November 4, 2008, the mutual fund trade organization, the Investment Company Institute (ICI), announced the formation of a panel of fund industry leaders with a mandate "to develop recommendations to improve the functioning of the money market and the operation and regulation of funds investing in that market." The panel was chaired by former Vanguard CEO John Brennan. .

The panel presented its completed report to the ICI's Board on March 17, 2009. The report offered 24 recommended actions for improving fund safety.

On February 23, 2010, the SEC adopted three amendments to rule 2a-7 which governs money market funds. The rules were effective June 30, 2010. The changes to existing rules are as follows:
 * 1) The Weighted Average Maturity (WAM) for money market funds is reduced from 90 days to 60 days.
 * 2) Liquidity buffers are introduced for taxable money market funds (a minimum 10% of assets must be cash, treasury securities, or securities that convert to cash in one day; a minimum 30% of assets must be cash, treasury securities or certain government securities with remaining maturities of 60 days or less, or securities that convert to cash within one week.)
 * 3) Tighter restrictions on the amount of higher risk second-tier securities a money fund can hold (now a maximum limit of 3% from the former limit of 5%; and a maximum limit of 0.5% to any single issuer, from a prior limit of 1%.) Investment in second tier securities is restricted to maturities of 45 days or less.

The 2014 money market fund reforms
On July 14, 2014 the SEC issued final rules that "... make structural and operational reforms to address risks of investor runs in money market funds, while preserving the benefits of the funds."

The SEC’s final rules "... require a floating net asset value (NAV) for institutional prime money market funds, which allows the daily share prices of these funds to fluctuate along with changes in the market-based value of fund assets and provide non-government money market fund boards new tools – liquidity fees and redemption gates – to address runs." The Internal Revenue Service is formulating a simplified aggregate method of accounting applicable to investors in floating NAV money market funds.