U.S. money market funds represent a key potential source of systemic risk, suggests BMO Capital Markets in a new report.
BMO notes that the U.S. Federal Reserve Board has proven reluctant to try and boost credit by eliminating the interest paid on its holdings of excess reserves, as the European Central Bank has recently done successfully; despite the fact that Fed chairman Ben Bernanke recently suggested that doing so could save the U.S. Treasury about US$2.5 billion a year in interest charges and may encourage easier credit conditions.
“The Fed’s reluctance stems from fears of systemic risk in the money market funds (MMFs) industry,” BMO says, noting that these funds are a key source of capital for business and government, and an important investment vehicle for households, accounting for almost 25% of all mutual fund assets in the U.S.
However, the financial crisis showed that these funds can be vulnerable to investor runs, as happened in the wake of the Lehman Brothers bankruptcy. At the time, the Fed took emergency action to help end the run and stabilize the money fund market. And, BMO says, the Fed remains “very mindful of the inherent systemic risk associated with MMFs”.
“MMFs are one important channel through which Europe’s crisis could impact U.S. financial markets, as many may still be invested in European bank paper, causing significant dislocation and widespread disruption,” it notes.
In the meantime, BMO says, the Fed is analyzing methods to mitigate the risk of significant redemptions in the event of a crisis. Still, it concludes that the Fed is unlikely to eliminate interest on excess reserves anytime soon.