The crisis in the euro area is a reminder that threats to financial stability are never far away. While progress has been made on financial reform over the past two years, more must be done to ensure that the financial system is robust enough to absorb shocks and still provide the credit needed for economic growth and job creation.
A glaring vulnerability exists with money-market mutual funds. I believe changes along the lines proposed by Mary Schapiro, the chairman of the U.S. Securities and Exchange Commission, are essential. In particular, money funds should have capital buffers and modest limits on investor withdrawals. Such reforms are necessary to protect the economy from financial instability in the future.
When money-fund investors perceive any danger that a fund could “break the buck,” meaning that it doesn’t have enough money left to repay investors in full, they have a tremendous incentive to head for the exit. After all, if they are first in line, they can get out while the fund can still pay out dollar-for-dollar, leaving other investors to suffer all the losses. Large sophisticated investors tend to run first, leaving small investors behind.