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Until 2011, money market mutual funds (MMMFs) represented the second largest category of the mutual fund industry in the United States. With $2.7 trillion in total net assets (TNA) as of December 2013, MMMFs account for about 18 percent of the TNA held by mutual funds in the United States. MMMFs are an important investment vehicle for individual investors and are vital liquidity providers to financial intermediaries. Investors regard MMMFs as safe money market instrument investments that provide yields above those of bank deposits. The main difference between bank deposits and MMMFs is that the Federal Deposit Insurance Corporation (FDIC) does not insure MMMFs. As evidenced by the Lehman Brothers bankruptcy in 2008 and the 2011 European banking crisis, MMMFs may threaten the stability of the financial system. This chapter offers a general overview of the history, structure, performance measures, and role of MMMFs in the financial system.

Prime money market mutual funds (MMF) are particularly susceptible to runs given the inherently short-term nature of their liabilities and the riskiness of their assets as compared with government funds. Thus, it is a proper object of policy to minimize the possibility of prime money market fund runs. This chapter discusses the SEC's approach to MMF reform. The approach incorporates three elements: (1) enhanced liquidity requirements; (2) a floating net asset value (NAV) requirement for certain classes of money market funds; and (3) the possibility of imposing liquidity fees and redemption gates on money market funds, which would limit rapid MMF creditor outflows in times of stress. It specifically rejected imposing a capital requirement on these funds. At the outset it should be clear that the concern with contagion should only be with prime money market funds and municipal funds, and not with government funds, which are all but immune from runs.

This chapter analyzes the possible need for insurance of money market mutual funds. The issue is of particular concern given the vulnerability of those funds, in particular, prime institutional funds, to contagious runs due to the money-like nature of their liabilities. It argues that the true competitive impact of expanded insurance on the banking and money market industries requires more detailed study of the appropriate cost and pricing of insurance, before any firm conclusions can be drawn. Given all of the difficulties of extending an insurance regime to money market funds, a more practical approach might be to make clear funds are eligible for lender-of-last-resort support either directly or indirectly through the banks. Liquidity support may be sufficient by itself to stop runs.

The Glass-Steagall Act created a decentralized financial system composed of three separate and independent financial sectors—commercial banking, securities markets, and insurance. The Bank Holding Company Act of 1956 reinforced Glass-Steagall’s policy of structural separation by prohibiting bank holding companies from engaging in any activities that were not “closely related to banking.” Glass-Steagall’s structural barriers prevented the occurrence of systemic financial crises for more than four decades. During that period, federal regulators could deal with problems arising in one financial sector without need to rescue the entire financial system. Despite Glass-Steagall’s success, federal agencies and courts undermined its prudential buffers during the 1980s and 1990s by opening loopholes. Those loopholes allowed banks to convert their loans into asset-backed securities and to offer derivatives that functioned as synthetic substitutes for securities and insurance products. Regulators and courts also allowed money market mutual funds and other nonbanks to issue short-term financial claims that served as deposit substitutes, despite Glass-Steagall’s prohibition against deposit-taking by nonbanks.

This chapter discusses the diagnosis of the economic crisis presented by previous chapters. The chapter first argues against the statement that the Glass-Steagall Act disrupted the period of financial stability between the 1930s to the early 1980s. The chapter then goes on to explain that the decision to allow the market in over-the-counter derivatives to balloon without any public oversight was a public-policy error of the first order. Therefore, the Glass-Steagall act was not a principal cause of the recent crisis. The chapter then discusses the problem of money-market mutual funds, which is viewed to have become a source of systemic risk that warranted action from the Department of the Treasury. The chapter goes to outline some theories and examples for how to balance these risks. The chapter ends with the imperative that practicing finance is more important than simply regulating finance. Hence, effective financial oversight is a necessity.

This chapter introduces the first signs that the United States is emerging from a period of failure of liquid markets such as markets for money-market mutual funds, for asset-backed commercial paper, and for auction-rate securities. It is the chapter’s view that this crisis and all its problems could not have been prevented by regulation alone. Instead, a more robust regulatory framework with oversight responsibility for cross-market activities and a focus on systemic risk is what could have discovered and pre-empted the dangers on the economy. The chapter goes on to discuss a blueprint for a modernized financial regulatory structure that could help improve the mortgage-origination process and establish some federal presence in the insurance markets. This blueprint is aimed to address the regulatory problems of market stability, prudential supervision, and oversight of business conduct and consumer protection. It focuses on systemic risk in order to improve regulatory efficiency and allow competition on an economic basis.