The effect of the Money Market Mutual Fund Liquidity Facility (MMLF) on corporate short‐term borrowing costs

• Published date: 01 September 2023
• Author: Karen Y. Jang
• Date: 01 September 2023
• DOI: http://doi.org/10.1111/jfir.12326

Received: 17 September 2021

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Accepted: 1 March 2023

DOI: 10.1111/jfir.12326

ORIGINAL ARTICLE

The effect of the Money Market Mutual Fund

Liquidity Facility (MMLF) on corporate

short‐term borrowing costs

Karen Y.Jang

Department of Finance, Indiana University,

Bloomington, Indiana, USA

Correspondence

Karen Y. Jang,1309 E. 10th Street,Hodge

Hall, Bloomington, IN 47405, USA.

Email: yeonjang@iu.edu

Abstract

In this article, I study the effect of the Money Market Fund

Liquidity Facility (MMLF) on corporate short‐term borrow-

ing costs. Although MMLF loans accept a broader range of

collateral acquired from money market funds (MMFs) than

Asset‐Backed Commercial Paper Money Market Mutual

Fund Liquidity Facility (AMLF) loans, their higher loan

rates could make the intervention less effective. I find

the average yield has decreased by 20–24 basis points. The

yield‐decreasing effects of the MMLF are stronger for

securities issued by eligible non‐US firms, non‐asset‐

backed commercial paper securities that are newly

accepted as collateral under the MMLF, and securities held

by affiliated MMFs. However, I do not find an additional

yield‐decreasing effect of the MMLF on lower rated

securities or nonfinancial sector securities. After the

implementation of the MMLF, domestic MMFs seem to

increase the weight of nonfinancial sector securities, which

helps them achieve a higher return.

JEL CLASSIFICATION

G18, G23

J Financ Res. 2023;46:605–629. wileyonlinelibrary.com/journal/JFIR

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605

This is an open access article under the terms of the Creative Commons Attribution‐NonCommercial‐NoDerivs License, which

permits use and distribution in any medium, provided the original work is properly cited, the use is non‐commercial and no

modifications or adaptations are made.

© 2023 The Authors. Journal of Financial Research published by Wiley Periodicals LLC on behalf of The Southern Finance

Association and the Southwestern Finance Association.

The author thanks conference participants and the discussant at the 33th Australasian Finance and Banking Conference and the 2021 FMA for useful

insights and helpful comments.

1|INTRODUCTION

As COVID‐19 spread rapidly in the United States, fears of its economic fallout led to disruptions in the financial

market. In an effort to insulate the US economy from the coronavirus pandemic, the Federal Reserve (Fed) quickly

reestablished emergency facilities created during the 2007–2008 financial crisis, as severe price and liquidity

dislocation occurred in many financial markets. One of them was the Money Market Fund Liquidity Facility (MMLF),

announced by the Fed on March 18, 2020. The MMLF was set up to provide nonrecourse collateralized loans to

eligible borrowers (i.e., mainly banks), which purchased, with the MMLF loans, securities from US domestic money

market funds (MMFs). This facility, in principle, reproduced the structure of the Asset‐Backed Commercial Paper

Money Market Mutual Fund Liquidity Facility (AMLF) established in 2008 when MMFs experienced a “run”because

of their asset‐backed commercial paper (ABCP) holdings. A major difference was that the new MMLF covered a

broad range of collateral acquired from MMFs rather than just ABCP, as the imminent threat to MMFs was the

COVID‐19−related general rush to liquidity. Another big departure from its predecessor was that loans secured by

nongovernmental collateral bore interest at 1% above the primary credit rate. In comparison, the AMLF extended

loans at the Fed's primary credit rate and eligible borrowing institutions purchased ABCP from MMFs at amortized

cost. This implies that as long as money markets were disrupted and ABCP holdings of MMFs paid rates in excess of

the primary credit rate, the borrowing institutions earned a positive spread for AMLF loans (Duygan‐Bump

et al., 2013). Therefore, the 1% spread for nongovernmental debt collateral seemed to raise questions about the

effectiveness of the facility: At 1% above the primary credit rate, loans to finance purchases of private short‐term

debt securities bore interest at 1.00%–1.25%. The Fed's H.15 release showed that commercial paper issued on

March 12 and 13, 2020 bearing effective interest rates below 1.25% following the Federal Open Market

Committe's (FOMC) 50‐basis‐point (bp) reduction in the target federal funds rate on March 3, 2020.

1

To be sure, CP

rates spiked well above 1.25% later in the month, as shown on H.15, despite the FOMC's March 15 reduction in the

target rate by 100 bps. Yet, it was still unclear how eligible financial institutions would use a loan with an interest

rate at 1.00%–1.25% from the MMLF to prioritize liquidity provision to money markets. Therefore, it was less

evident how the MMLF would in turn affect average corporate borrowing costs in the short‐term funding market

and the portfolio holdings of MMFs.

In this article, I study the effectiveness of the MMLF in relieving the strains in the money market at the

outbreak of COVID‐19 by investigating the relative yield changes of nongovernmental short‐term debt securities

held by MMFs. Although the initial behavior of money market investors resembled the panic of the 2007–2008

financial crisis, it does not necessarily mean the MMLF would yield the same results as the AMLF. In addition, the

fundamental causes of thetwo crises were verydifferent: The 2007–2008 downturn was the result of a banking

crisis that dried up financing but the COVID‐19 crisis was initially caused by physical barriers to trading goods and

services. Thus, a careful examination of the effect of the MMLF on relieving liquidity concerns in the money market

is called for to assess the effectiveness of emergency liquidity facilities employed by the Fed during the COVID‐19

crisis.

The government stepped in with a broad array of actions to limit the economic damages from the pandemic.

The Coronavirus Aid, Relief, and Economic Security (CARES) Act, passed by Congress and signed into law on March

27, 2020, provided $2.2 trillion in direct aid to individuals and businesses, the largest stimulus package in US

history. The Fed also flooded the market with liquidity by authorizing the establishment of numerous credit

facilities.

2

All these relief measures and lending facilities make it difficult to identify the sole effects of the MMLF

1

https://www.federalreserve.gov/releases/h15

2

The lending facilities include the Primary Dealer Credit Facility, Commercial Paper Funding Facility, Money Market Mutual Fund

Liquidity Facility, Term Asset‐Backed Securities Loan Facility, Secondary Market Corporate Credit Facility, Primary Market

Corporate Credit Facility, Municipal Liquidity Facility, Paycheck Protection Lending Facility, Main Street New Loan Facility, and Main

Street Expanded Loan Facility.

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JOURNAL OF FINANCIAL RESEARCH