During the wave of banking regulation that followed the Great Depression, the government slapped heavy controls on the interest rates that banks could offer.  They weren't very good, which made the banks sounder, and consumers worse off.  When inflation and interest rates rose in the late sixties, this became a big problem.  Then some clever chap came up with the money market fund.  Legally it worked like an investment fund, not a bank account: you invested in shares, with each share priced at a dollar.  The fund invested in the commercial paper market and committed to keep each share worth exactly one dollar; whatever investment return they got was paid out as interest on your shares.  This gave you something that looked a lot like a bank account, without all the legal tsuris.


In 2008, it turns out that these money market accounts were--as was always pretty obvious--a lot more like bank accounts than mutual fund shares.  The Reserve Primary fund held a lot of Lehmann Brothers commercial paper, which plunged close to zero, meaning that there were no longer enough assets in the fund to make all the shares worth at least a dollar.  This is known as "breaking the buck", and it was not the first time it had happened.  But it was the first time in more than a decade that it had happened at a fund which didn't have enough money to top up the assets in the fund to bring them back to a value of $1.  Bigger investment houses had been quietly topping up their money market funds for month, but Reserve Primary was a smaller firm, and they didn't have the spare cash handy.

This triggered a run on the money markets, which the government really only stopped by a) passing TARP and b) guaranteeing money market funds.  But as Matt Yglesias points out, Dodd-Frank stripped Treasury of the authority to do such a thing again. And now the money markets are exposed to a Greek default:

But according to Landon Thomas, Jr.'s reporting for the New York Times (hat tip Tyler Cowen), there's a threat of this happening again. This time not with the failure of an investment bank, but with a failure of Greece to pay its debts. Apparently "as of February, 44.3 percent of prime money market funds in the United States were invested in the short-term debt of European banks" including "French banks like Société Générale, Crédit Agricole and BNP Paribas" with significant exposure to Greek debt.

This time around, though, there may be a problem. As Brian Beutler explained last July, the Dodd-Frank Wall Street regulatory overhaul deprives Treasury of the legal authority that was used to backstop money market funds at the time. When Treasury officials were asked about this at a meeting with bloggers several months ago, they gestured in the direction of the idea that their resolution authority tools would help avoid a replay of the whole scenario. But Dodd-Frank obviously doesn't give the Treasury Department the authority to engage in an orderly liquidation of Greece. That means, as best as I can tell, that we're left to hope the folks running the European Union know what they're doing even though very little in their recent performance bolsters that hope.

I don't think this is reason to panic; I'm going to assume that that 44.3 precent of prime money market funds is a percentage of the number of funds, not a percentage of the assets held in such funds.  You need quite a chain of events--European countries allowing their banks to fail, and then the funds that hold their commercial paper not having any corporate owner who can afford a top-up--before we get another run on the money markets.

Still, if there's one thing that 2008 taught me, it's never to entirely discount the possibility of catastrophe.  This is one to watch.

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