How Money Market Funds React to Crisis

Lessons from the Eurozone Debt Crisis

Dec 10, 2020
As Featured In 
Review of Financial Studies

How do U.S. money market funds respond to a crisis? That’s what Maryland Smith finance professor Russell Wermers wondered in recently published research that explores what happened during the European debt crisis that spiraled when Greece required a bailout.

“Fund managers were really focused on Eurozone debt at that time, and so U.S. money market funds responded by scaling back on Eurozone debt and chasing yield in other areas of the world where their investors were not focusing,” says Wermers.

He worked with co-authors Emily Gallagher of the University of Colorado at Boulder, Lawrence Schmidt of Massachusetts Institute of Technology, and Allan Timmermann of the University of California, San Diego on the research, published in the Review of Financial Studies, a top scholarly journal.

The study is a follow-on to Wermers' earlier work on what happened with money market funds after the 2008 financial crisis. In the 2008 crisis, the U.S. Department of the Treasury and the Federal Reserve had to back up money market funds because they were on the verge of failing, says Wermers. After that, he says, the Securities and Exchange Commission, put into place more disclosure regulations. Now, every month, every money market fund out there has to disclose all the securities they are holding.

“For each money market fund, we now know their holdings of every single commercial paper or repo or bank CD, or whatever.”

In this latest paper, Wermers and his co-authors use that change in regulation to look at the 2011 Eurozone crisis, the only other big crisis to hit the money market fund industry, says Wermers – “well, at least up until COVID hit this year in March.”

“That was an especially difficult period among all the Eurozone crises that have happened,” says Wermers. “That was when the Greek debt was first determined to be in serious risk of defaulting.”

Wermers says all Eurozone debt during that time period was considered “hazardous waste,” by money market fund investors, so he and his co-authors looked at what European debt, issued by E.U. banks or companies, that U.S.-based money market funds decided to hold or sell. They compared it to what those same funds did with debt issued by North American, Asian and other entities.

“The moral of the story was that during the Eurozone crisis, U.S. money market funds sold off or did not refresh their holdings of Eurozone short-term debt obligations, but they did not curtail their holdings of similarly rated North American and Asian short-term fixed income holdings,” says Wermers.

Sophisticated Investors in money market mutual funds have a limited amount of attention, says Wermers, so they end up focusing on big stories – like the European debt crisis – and reacting to those with their investment decisions.

“We find that sophisticated investors selectively acquire information about MMFs’ risk exposures to Europe, which leads managers to withdraw funding from information-sensitive European issuers,” write the researchers.

That’s why money market fund managers serving the most sophisticated investors selectively adjust their portfolio risk exposures to avoid information-sensitive European risks, while maintaining or increasing risk exposures to other regions.

Read the full research, “Investor Information Acquisition and Money Market Fund Risk Rebalancing during the 2011-12 Eurozone Crisis,” in the Review of Financial Studies.


About the Author(s)

Russ Wermers is Professor of Finance at the Smith School of Business, University of Maryland at College Park, where he won a campus-wide teaching award during 2005 and a Krowe Teaching Award (within the Smith Business School) during 2013. His main research interests include studies of the efficiency of securities markets, as well as the role of institutional investors in setting stock prices. In addition, he studies and teaches quantitative equity strategies, and is currently researching microfinance institutions in Thailand. Most notably, his past research has developed new approaches to measuring and attributing the performance of mutual funds, pension funds, and hedge funds, as well as devising winning strategies for investing in these funds.

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