MMFs’ stable NAVs and the methods used to keep them steady in normal times also make the funds susceptible to runs in unusual times, and these runs pose broad systemic risks. In part, these risks arise because the historical record of MMFs keeping NAVs steady (only two money funds have “broken the buck” since 1983, when the SEC adopted rule 2a-7) has attracted a large, highly risk-averse shareholder base that includes many institutional investors. These shareholders reportedly place great value on principal stability and are prone to fleeing money funds quickly at any sign of trouble. Importantly, because of the sheer size of the money fund industry and its importance in providing short-term funding to financial institutions, MMFs’ vulnerability to runs not only puts their investors at risk, but also poses considerable systemic risk to the U.S. financial system, as was observed in the fall of 2008.

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In addition, MMFs’ liquidity management practices, while they contribute to principal stability, also increase investors’ incentives to run from the funds. MMFs meet redemptions by selling their most liquid assets, rather than selling a cross-section of all of their holdings. This practice allows an MMF to avoid realizing losses from sales of less liquid securities and, as long as all investors do not redeem at once, effectively provides shareholders with more liquidity than they would have individually. But during periods of market strain, when less-liquid assets may sell at deep discounts, redeemers who receive $1 per share bear none of the implicit liquidity costs of their redemptions. Rather, remaining investors are left with claims on a less-liquid portfolio. For this reason, shareholders have an incentive to run from troubled money funds as they leave behind risks and costs to be borne by those who remain invested in the fund.