How Money Market Funding Can Fail During a Credit Crisis
Summary
The document explains how stress in bank credit can disrupt money markets and money market funds. During the 2008 crisis, concern about lending to banks weakened the market value of bank commercial paper. Investors seeking redemption at par could then prompt runs on funds holding that paper, while banks faced difficulty replacing short-term commercial paper as it matured. The account illustrates how perceived credit risk, fund redemptions, and banks’ rollover needs can reinforce one another.
The responses also note that money market funds can incur principal losses: some funds were publicly reported to have broken the buck, while sponsoring organizations reportedly supported others. The document mentions reduced bank dependence on commercial paper and a proposed requirement for some funds to use a floating net asset value as possible changes that might limit these pressures. It offers a crisis narrative and historical examples, not a quantitative forecast or a claim that every money market fund will fail. Its central lesson is that money market instruments and funds can face liquidity and credit pressure precisely when institutions need reliable short-term financing.
Key ideas
- Money markets can come under severe pressure during a credit crisis.
- Doubts about bank commercial paper can reduce its value and weaken investor confidence in funds holding it.
- Redemptions from funds seeking par value can intensify stress on fund liquidity.
- Banks that cannot roll over short-term paper must find replacement funding as obligations mature.
- Fund support and changes in bank funding or fund valuation practices may affect how these pressures unfold.
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Full text
# Can the money market break in a crisis situation? # Can the money market break in a crisis situation? I am researching the question, what happens during a crisis situation to the money market. Can it break? In 2007-08 there is evidence that liquity hoarding from banks became a rather common problem. (See f.ex. Berrospide 2012) I in a risk statement(which I cannot find anymore) that the ECB does not see the money market as a secure way to fund a bank in a crisis situation and somehow I interprete from this that it only sees itself as the real constant during a financial crisis. Does the money market hold in a severe crisis situation? I appreciate your experienced answers! ## Answer by dm63 (score 3) https://quant.stackexchange.com/a/21938 Clearly the money markets are likely to freeze up in a crisis situation. They did exactly that in 2008. Specifically: A) people don't want to lend money unsecured to banks, so bank commercial paper goes below par in the market. B) understanding this , people try to liquidate money market funds containing bank cp at par, so a run develops on money market funds. C). Banks are then unable to roll their cp funding into new cp, so they must find other sources of funding when the cp matures. There have been some changes which hopefully will decrease these effects next time there is s crisis: Banks have reduced their reliance on commercial paper and other short term funding. Also , there is legislation being considered that would require money market funds containing bank and corporate paper to maintain a nav instead of always being at par. However there isn't much doubt that the money market will be under pressure whenever there's a credit crisis. ## Answer by Larasing (score 1) https://quant.stackexchange.com/a/21915 The money market fund could suffer principle loss during crisis and one of them publicly did during the crisis of 2008. I say publicly because there are funds that suffered large loss that would have had them 'break the buck' except their sponsoring organizations bailed them out. I urge you you check out this New York Fed research for a comprehensive look at this topic. http://libertystreeteconomics.newyorkfed.org/2013/10/twenty-eight-money-market-funds-that-could-have-broken-the-buck-new-data-on-losses-during-the-2008-c.html#.VlSeC7__wWA
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