On Tuesday we left off with a promise to do a post focusing on the Fed’s Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility (AMLF) and Money Money Market Investor Funding Facility (MMIFF). We’re making good on that promise. Whereas the Commercial Paper Funding Facility (CPFF) was targeted primarily at issuers of commercial paper and intended to improve market conditions for businesses that rely on the CP market to finance themselves, both the AMLF and MMIFF are targeted at money market funds (MMFs) and helping them meet escalating redemption requests.

A Bloomberg article by Christopher Condon and Bryan Keogh does a nice job of describing the circumstances immediately preceding the creation of the AMLF:

“While money funds were selling commercial paper in the past few months, the exodus accelerated after the bankruptcy of Lehman Brothers Holdings Inc. on Sept. 15 and the breakdown of the nation's oldest money-market fund the next day.”

“The $62.5 billion Reserve Primary Fund announced Sept. 16 that losses on debt issued by Lehman had reduced its net assets to 97 cents a share, making it the first money fund in 14 years to break the buck, the term for falling below the $1 a share that investors pay. Over the next two days, investors pulled $133 billion from U.S. money-market funds, according to IMoneyNet.” (emphasis added)

As has been publicized, the large withdrawals from money market funds were not without consequence. MMFs provide a link between investors looking to earn a return on their money and businesses looking to sell their short-term debt. A break in the link can lead to reduced business activity and pose risks to economic growth.

Conditions in the commercial paper market had already been under stress prior to the Reserve Primary Fund’s losses. Weak demand for CP and the massive outflows from MMFs forced some funds to sell the paper in an illiquid market—leading in some cases to losses, something that isn’t supposed to happen in MMFs.

Compounding the issues in the CP market was a reallocation of MMFs’ portfolios toward safer Treasury securities. In addition to the desire of MMFs to shed CP and other assets to meet redemptions, MMFs have been reallocating their assets toward safer, more liquid, Treasuries. MMFs were not alone.