Money Markets Pose Systemic Risk

Today, James Staley, head of JPMorgan Chase & Co.’s investment unit, said at a lunch discussion hosted today by Credit Suisse Group AG in Davos, Switzerland that the $4 trillion money-market fund industry is the “greatest systemic risk” to the financial system that hasn’t been adequately addressed.

His point actually emphasized the nature of money market fund, that is the funds aren’t allowed to set aside capital to protect for investment losses, leaving no “margin for error” against a potential collapse.

If you’re running a money-fund and all of a sudden you think there may be a slight run or a problem in the credit markets you have to liquefy your portfolio as fast as you possibly can because your margin of error is zero because there’s no shock absorber or capital insurance protecting that.

It partly explained why Lehman could collapse so quickly. Money market funds, which typically hold highly rated, short-term debt instruments, were forced to pull their money from the firms when they saw any signs of trouble.

Against the nature of no insurance behind money market funds, Fed and other policy makers may need pay some attention to back this industry to stabilize the financial market.