The Catholic University of America

Professor David Lipton, director of Catholic University's Securities Law Program, and Robert E. Plaze, associate director for regulation, Division of Investment Management, U.S. Securities and Exchange Commission.


Money Market Funds and their Complex Role in Financial Markets

Money market funds are the most popular form of investment in America. Introduced in 1972, they soared in cumulative value from $180 billion to $3.9 trillion in 35 years. Most investors park whatever cash or retirement savings they can into such funds, and let professional money managers do the rest.

Simple in design, money market funds in reality are complex and challenging to regulate, according to Robert Plaze, associate director for regulation, Division of Investment Management, U.S. Securities and Exchange Commission.

"The back-end is very complicated from a regulator's point of view," he said.

Speaking at the law school on Sept. 14 at the invitation of the Securities Law Program and the Securities Law Student Association, Plaze devoted his presentation to an explanation of what money market funds really are, why they are difficult to closely regulate, and the significant yet little understood role they play in today's current financial difficulties. His talk to students and alumni was delivered on the first anniversary of the bankruptcy filing of Lehman Brothers, a now-defunct global financial services firm which was a primary dealer in the U.S. Treasury securities market.

Plaze explained that the troubles already brewing in other parts of the financial sector were accelerated in Sept. 2008, when the Reserve Primary Fund (a leading money market fund) "broke the buck," i.e., its share value fell to less than $1.00. 

Though not emphasized often, the breaking of the buck caused some of the most crippling financial problems that followed. Money market funds amounted to a $3.4 trillion dollar "shadow" banking system which supplied the U.S. financial and manufacturing industry with short-term loans through the purchase of commercial paper. Commercial paper is an unsecured promissory note that is only backed by an issuing bank or corporation's promise to pay the face amount on the maturity date specified on the note.

When the Reserve Primary Fund shares fell to under $1.00, alarm began to spread through money markets everywhere. Many investors, no longer assured that their money would at least be returned dollar for dollar, chose to pull their funds out of the money markets and switch them into other investments such as gold or treasury bonds. This outflow of cash sharply accelerated what was already a liquidity crisis.

Plaze closed his talk with a discussion about what is being proposed to ensure that the liquidity crisis, and the depletion of money market funds that helped to fuel it, does not occur again.