It can’t happen here?: Cyprus and money market funds

Cyprus of course differs from the U.S. in many significant ways, and furthermore I recoil at the notion that America is the “next Greece,” or who otherwise make inappropriate international comparisons.

Still, what if we try to look for the closest parallel possible? What is the closest the United States could come to a Cyprus-like situation?

The all-too-vulnerable arm of our U.S. financial system is money market funds.  That is about $2.7 trillion on the books, much of it driven by regulatory arbitrage.

Ten percent of the assets of money market funds are supposed to be liquid.  Yet the average capital cushion is quite low, as the industry resists attempts to impose a legal one to three percent buffer (here is one proposal for capital cushions and a class A/class B structure).  Post Dodd-Frank it is much harder, arguably impossible, for the Fed to bail out money market funds, as was done in 2008.  So our control over our own currency may not pay off on this issue.

There are repeated and largely unheeded warnings of money market funds as a source of systemic risk.  Some of the common proposals for money market funds involve “standby liquidity fees” and “temporary redemption gates.”  Sound familiar?  Of course losses on these assets could not approach the Cyprus level but still we could have a disastrous run.

I am not suggesting there is an easy way to solve this problem, or that a crisis will happen anytime very soon.  I am simply noting that, along at least one dimension, we are more vulnerable than is commonly realized.  We are just a little more like Cyprus than one might think.


Comments for this post are closed