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.


But was this not already put to the test the last few years? Hundreds of banks closed, money market funds breaking the buck. Deposit insurance fulfilling its function. The FDIC might be unsung, but they did their jobs. Too bad Europe doesn't have one, and a fund filled to the brim by a bank levy in the good times that backed up that deposit insurance.

FDIC almost went bankrupt with the government bailouts and Sheila Bair arguing for more bank busts. I still don't understand the argument that the worst clusterfoible in almost 80 years should have been worse.

That is not what happened

¨ When Lehman Brothers Holdings Inc. filed for bankruptcy. On Tuesday, September 16, 2008, Reserve Primary Fund, the oldest money fund, broke the buck when its shares fell to 97 cents after writing off debt issued by Lehman Brothers. The resulting investor anxiety almost caused a run on money funds, as investors redeemed their holdings and funds were forced to liquidate assets or impose limits on redemptions: through Wednesday, September 17, 2008, prime institutional funds saw substantial redemptions. Retail funds saw net inflows of $4 billion, for a net capital outflow from all funds of $169 billion to $3.4 trillion (5%). In response, on Friday, September 19, 2008, the U.S. Department of the Treasury announced an optional program to "insure the holdings of any publicly offered eligible money market mutual fund—both retail and institutional—that pays a fee to participate in the program". ¨

In other words, a moral hazard totaling $2.7 trillion dollars in a massive government bailout of businesses and individuals who thought money market funds were bank accounts from which they could withdraw their money on demand.

Something the money market fund managers stated would never ever ever happen back circa 1970 when they were seeking deregulation from rules that required a minimum of three days between order to withdraw funds and delivery of the cash, a maximum of one withdrawal a month, and other rules that were enforcing "money market funds are not insured depository banks".

Given many/most money market funds hold US Treasuries, if Bachmann and the Tea Partiers had succeeded in forcing defaults on US Treasuries redemptions in 2011, would a fund imposing delays on withdrawal due to market turmoil for these bonds triggered runs on the other funds resulting in more capital controls, thus freezing accounts used for payrolls, payables, dividends, which fund managers plan for by laddering short term bonds.

That only a few billion dollars would be delayed without any panic is irrelevant if a panic drives even a hundred billion in unusual withdrawal demands, a mere 3% of the funds. The Money Market Investor Funding Facility (MMIFF) created in September 2008 provided money market funds $152 billion cash by Oct 1, 2008, something never done before. See and

In other words, the Fed provided 90% of the cash needed by money market funds during their bank run until the Fed and FDIC stopped the run by the promise to cover all private sector losses in money market funds. (Not exactly true, but that's how people heard it).

"Given many/most money market funds hold US Treasuries.."

They don't. They hold asset backed commercial paper.

Since the debacle of the Canadian Asset Backed CP melt down in 2007, I doubt you'll find much ABCP out there.

Much of it was synthetic backed and bought by hedge funds, apparently. Again use of synthetics is way down post crash.

It was not FDIC's job to backstop money market funds.

Without disagreeing that money market funds in their current form are risky, they do seem to be safer than banks. If forced to choose between regulating MM funds like banks and regulating banks like MM funds, I'd rather have MM fund regulation.

More or less seconded. I don't know enough about MM regulation to truly comment but the main point, that banks are vulnerable as it is and a systemic danger on their own, seems entirely correct to me.

Basically, sure, reform MMs too. But banks ought to be re-reformed as well.

The issues are political and, more precisely, the political weight financial donations have given the banks. If it wasn't legal, it'd be called corruption.

The money market regulations assumed the money market funds would impose capital controls and freeze and restrict withdrawals. Primary Reserve should not have resorted to the government bailout-takeover of bankruptcy. The thousands of money market funds should have largely prohibited withdrawals of funds, or required days, weeks, months of advance notice.

That is what the money market funds said they would do circa 1970 if September 2008 happened.

Instead they sought a government bailout so that money market funds would not have been tarred as being as trustworthy as the Cypress banks are today.

Of course, people who needed their money out of money market funds wanted government bailouts because they expected money market funds to be just like FDIC insured deposits.

The fact that money market funds were bailed out means that the much higher risk in theory of money placed with them instead of in banks has been inverted. Max believes after the moral hazard bailout of the money market funds which did not pay the price of Fed membership and of FDIC being bailed out just like FDIC accounts that the money market funds are safer.

Max considers money market funds safer because he expects they will be the first to be bailed out in a future crisis. Or else he expects money market funds will be safer because they will be like Cypress banks with frozen accounts, withdrawal restrictions, and haircuts on account balances???

I am marvelling at the concept of 'Cypress banks'.

What if they catch fire? ;-).

But it can be shown mathematically that all fractional currency reserve schemes, be it money market or banks (which arguably are less safe, since they try and match short term liabilities and long-term assets) are inherently unstable. Which to me argues against having FDIC insurance.

Party factoid: of the 40% of banks that failed from 1929 to 1933, pre-FDIC, bank account holders lost on average about 20% of their savings in the failed banks. Well under 1% lost everything.

Does that mean FDIC insurance is undervalued? I can't imagine the federal government would not bail out the FDIC if it got into trouble. I'm wondering if people who hold assets as cash in banks are actually getting a pretty good deal because of the value of the FDIC insurance. It doesn't pay a return, but safety is a return in a sense.

I suspect that if the costs get too high there would be a more rigorous application of the rules as to size of deposits and the like.

'recoil at the notion that America is the “next Greece,” or who otherwise make inappropriate international comparisons'

Thankfully, no one needs to recoil from inappropriate international comparisons at Marginal Revolution. No sirree, this place is a font of only the finest international comparisons, and those who say otherwise are just being inappropriate.

That was a really dumb use of the term "regulatory arbitrage."

It is the standard way in which "regulatory arbitrage" is used.

No, he set up a strawman, then used the strawman as one leg of the alleged arbitrage opportunity.

A real use of the term would be to point out that there are two different kinds of money market funds (2a-7 funds and STIFs), each with their own regulatory regime.

It's a strange sort of arbitrage in that money market funds outperformed all of their competitors (Wall street banks, main street banks, Fannie and Freddie, etc.) and needed the smallest bailout. If it's arbitrage, it looks like MMFs raced to the top instead of the bottom.

"Cyprus of course differs from the U.S. in many significant ways": allow me to encourage you continue this line of dry wit.

I love how Tyler often offers a "Super Ridiculous Proposition" as bait which, of course, he (as a perfectly reasonable person) doesn't subscribe to, in order to later sneak in a softer "Less Ridiculous But Nevertheless Ridiculous Proposition" that now appears outright respectable juxtaposed next to its original, more ridiculous counterpart.

Right, Tyler should have written, Cypress banks differ in many respects from US money market funds...

But because insolvent institutions are subject to total government takeover by jack boot sheriffs under orders from black robed Federal government technocrats known as bankruptcy judges in the US, and similar bankruptcy judges elsewhere.

Thus the insolvent US money market funds and insolvent Cypress banks become government controlled, turning the issue into how government agents treat the depositors and other investors.

Hmm, it does come down to the US v Cypress...

Since presumably Cypress banks are made of a light wood, what happens if they burn? ;-).

For that to happen here, it would take a change in will amongst the US Treasury, which has done an "OK, we ensure all money market funds with no limit" a couple years ago when this looked plausible.

So the question is, what are the political odds of treasury being so stupid as to allow a bank run in this shadow banking area in the future when they've taken substantial action in the past to prevent such runs?

The question becomes can they come up with the money.

They have an F#@)(* printing press, and its all denominated in the same paper their press outputs. Yes, it would create an inflation "tax", but they can ALWAYS come up with the currency to back these guarentees.

"... we are more vulnerable than is commonly realized. "


And, of course, there's the infamous FDR Gold Confiscation of 1933. Very strong precedent that the U.S. government will indeed seize private currency/savings assets in a serious financial crisis.

The Gold Confiscation Of April 5, 1933:

From: President of the United States Franklin Delano Roosevelt
Presidential Executive Order 6102
Dated: 5 April, 1933

"Section 2. All persons are hereby required to deliver on or before May 1, 1933, to a Federal Reserve bank or a branch or agency thereof or to any member bank of the Federal Reserve System all gold coin, gold bullion, and gold certificates now owned by them or coming into their ownership on or before April 28, 1933... "

"Section 9. Whoever willfully violates any provision of this Executive Order or these regulation or of any rule, regulation or license issued there under may be fined not more than $10,000, or,if a natural person may be imprisoned for not more than ten years or both; and any officer, director, or agent of any corporation who knowingly participates in any such violation may be punished by a like fine, imprisonment, or both. "


Given the nature of the financial systems, the US is arguably no different in principle from Cyprus or Greece. We all may well die long before the US reaches it's own Greek-like denouement, but I don't see any reason to believe it will never happen. I think it only a matter of time.

This is from very recent canadian legislation. What is remarkable about cyprus and the pronouncements of the dutch fellow is the change. Not too long ago the spanish bonds were settled down by a promise that the central bank would buy them. Now depositor haircuts are being promoted.

My initial reaction to cyprus was oh they don't have the money, they are selling an optical backstop for €6 billion. The question then becomes whether the us treasury and fed could afford the massive injections of capital of 2009 if a similar situation arose. The promise of a growing economy due to monetary and fiscal stimulus hasn't materialized.

I don't think that the money would be available in the us if a similar collapse occurred. It then comes down to hoping it won't.

Canada is just saying that they are going to pre-commit to forcing debt for "equity" swaps in the event of bank insolvency. They are not saying which liabilities would be effected but it seems likely that any unsecured liability over the deposit guarantee limit would be swept up. This could be a better arrangement than the implicit government guarantee of all bank liabilities which appears to be in place in most of the Western world.

Tyler's comment is right on. Money market account holders think they have an implicit Federal guarantee without having to pay Federal insurance premiums, as bank depositors do. They may not be Russian mafia, but this is free-riding rent-seeking behavior. Sooner or later one of these funds will fail. The government should announce now, before it happens, that when the failure happens the account holders will take a haircut. Failure to announce it now guarantees a crisis later.

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