Stablecoins are digital assets whose value is pegged to that of fiat currencies, usually the U.S. dollar, with a typical exchange rate of one dollar per unit. Their market capitalization has grown exponentially over the last couple of years, from $5 billion in 2019 to around $180 billion in 2022. Notwithstanding their name, however, stablecoins can be very unstable: between May 1 and May 16, 2022, there was a run on stablecoins, with their circulation decreasing by 15.58 billion and their market capitalization dropping by $25.63 billion (see charts below.) In this post, we describe the different types of stablecoins and how they keep their peg, compare them with money market funds—a similar but much older and more regulated financial product, and discuss the stablecoin run of May 2022.
The incentives that drive bank runs have been well understood since the seminal work of Nobel laureates Douglas Diamond and Philip Dybvig (1983). When a bank is suspected to be insolvent, early withdrawers can get the full value of their deposits. If and when the bank runs out of funds, however, the bank cannot pay remaining depositors. As a result, all depositors have an incentive to run. The failures of Silicon Valley Bank and Signature Bank remind us that these incentives are still present for uninsured depositors, that is, those whose bank deposits are larger than deposit insurance limits. In this post, we discuss a policy proposal to reduce uninsured depositors’ incentives to run.
The size of the money market fund (MMF) industry co-moves with the monetary policy cycle. In a post published in 2019, we showed that this co-movement is likely due to the stronger response of MMF yields to monetary policy tightening relative to bank deposit rates, combined with MMF shares and bank deposits being close substitutes from an investor’s perspective. In this post, we update the analysis and zoom in to the current monetary policy tightening by the Federal Reserve.
In a Liberty Street Economics post that appeared yesterday, we described the mechanics of the Federal Reserve’s balance sheet “runoff” when newly issued Treasury securities are purchased by banks and money market funds (MMFs). The same mechanics would largely hold true when mortgage-backed securities (MBS) are purchased by banks. In this post, we show what happens when newly issued Treasury securities are purchased by levered nonbank financial institutions (NBFIs)—such as hedge funds or nonbank dealers—and by households.
A 2017 Liberty Street Economics post described the balance sheet effects of the Federal Open Market Committee’s decision to cease reinvestments of maturing securities—that is, the mechanics of the Federal Reserve’s balance sheet “runoff.” At the time, the overnight reverse repo (ON RRP) facility was fairly small (less than $200 billion for most of July 2017) and was not mentioned in the post for the sake of simplicity. Today, by contrast, take-up at the ON RRP facility is much larger (over $1.5 trillion for most of 2022). In this post, we update the earlier analysis and describe how the presence of the ON RRP facility affects the mechanics of the balance sheet runoff.
In March 2020, U.S. dollar-denominated prime money market funds (MMFs) suffered heavy outflows as concerns about the COVID-19 pandemic increased in the United States and Europe. Investors redeemed their shares en masse not only from funds domiciled in the United States (“domestic”) but also from offshore funds. In this post, we use differences in the regulatory regimes of domestic and offshore funds to identify the impact of the redemption gates and liquidity fees recently introduced as part of MMF industry reforms in both the United States and Europe.
Assets under management (AUM) of retail money market funds (MMF) have soared during monetary policy tightening episodes, lagging the spread between MMF yields and CD rates.
In December 2015, the Federal Reserve tightened monetary policy for the first time in almost ten years and, over the following three years, it raised interest rates eight more times, increasing the target range for the federal funds rate from 0-25 basis points (bps) to 225-250 bps. To what extent are changes in the fed funds rate transmitted to cash investors, and are there differences in the pass-through between retail and institutional investors? In this post, we describe the impact of recent rate increases on the yield paid by money market funds (MMFs) to their investors and show that the impact varies depending on investors’ sophistication.
Several academic papers have documented investors’ willingness to pay a premium to hold money-like assets and focused on its implication for financial stability. In a New York Fed staff report, we estimate such premium using a quasi-natural experiment, the recent reform of the money market fund (MMF) industry by the Securities and Exchange Commission (SEC).
The term “reach for yield” refers to investors’ tendency to buy riskier assets in hopes of securing higher returns. Do low rates on safe assets encourage such yield-seeking behavior, particularly among U.S. prime money market funds (MMFs)? In a paper forthcoming in the Journal of Financial Economics, I develop a model of MMF competition to understand whether competitive pressure leads these funds to reach for yield in a low-rate environment like the current one. I test the model’s predictions on the 2002-08 period and show that, after controlling for changes in risk premia, declines in risk-free rates actually reduced MMF risk-taking, leading to a “reach for safety.”