US money market fund reforms in 2014 led to a massive reallocation of cash from funds invested in private debt (prime funds) to funds invested in public debt (government funds).
Foreign banks, that were most dependent on prime money funds for funding, were deprived access to US dollars while the US Treasury and federal mortgage guarantee agencies attracted fund inflows.
Over time, the crowding out of the private sector has been mitigated. The surplus savings collected by government funds have been lent to banks, in the form of secured funding, both direct (repos backed by public-sector debt securities) and indirect through Federal Home Loan Banks (FHLBs).
However, the loss of funding caused by the withdrawal of prime funds has not been fully offset for foreign banks. Overall, the reforms have led to a transfer of liquidity from foreign banks to US banks.
The extension of the chain of intermediation through which savings are collected by money market funds and lent to banks (via FHLBs), along with the change in the nature of financing granted (higher share of secured funding), has been positive for banks’ liquidity coverage ratios (LCRs).
However, those two developments conflict with the objective of the money market fund reforms to promote the financial stability. The reforms expose money market funds, on the one hand, to financial institutions (FHLBs, Fannie Mae and Freddie Mac) that are heavily exposed to mortgage risk and that carry out a lot of maturity transformation, and, on the other hand, to the repo market, which is relatively opaque.
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by Céline CHOULET
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