Why the Federal Reserve had to step in again to stop runs on money market mutual funds and keep the financial system from imploding.
Topics covered include:
- What are the differences between shocks and vulnerabilities
- What are the four main vulnerabilities the Federal Reserve monitors
- How deleveraging and demands for liquidity lead to market stresses
- What are the types of money market funds and how were they impacted by the Covid 19 shock
- How was Treasury bond trading impacted by the Covid shock
- Why the Federal Reserve stepped in to stop the market contagion from spreading
- What are the downsides to central bank interventions
- What individual investors can do to protect against future shocks
U.S. Credit Markets Interconnectedness and the Effects of the COVID-19 Economic Shock by S.P. Kothari, Dalia Blass, Alan Cohen, Sumit Rajpal, and SEC Research Staff—U.S. Securities and Exchange Commission
Welcome to Money For the Rest of Us. This is a personal finance show on money, how it works, how to invest it, and how to live without worrying about it. I’m your host, David Stein. Today’s episode 333. It’s titled, “How the COVID shock nearly destroyed the financial system.”
A year ago today we reduced stock market exposure and credit risk in the Money For the Rest of Us Plus adaptive model portfolios. Overall investment conditions were downgraded to red, or bearish, for the first time since Money For the Rest of Us Plus was launched, in December 2014.
Economic trends have been red for nine straight months, but with the uncertainty of the Coronavirus and the sharp deterioration of market trends and market momentum, with very high fear among investors, we reduced risk. We took preventive action in the face of uncertainty. We weren’t exactly sure what was going on, how bad it could get.
Three Reports on the Covid Financial Shock
This past week I’ve read three government reports. The report of the President’s Working Group on Financial Markets Overview of Recent Events and Potential Reform Options for Money Market Funds. It was published in December 2020. I read U.S. Credit Markets Interconnectedness and the Effects of the COVID-19 Economic Shock, published by the U.S. Securities and Exchange Commission, published in October 2020, and I read the Financial Stability Report, published by the U.S. Federal Reserve in November 2020.
After reading the reports, I was frankly alarmed about how bad things could have gotten had the Federal Reserve not stepped in their role as lender and liquidity provider of last resort. Without the Fed and other central banks, there would have been a full-blown financial meltdown. Things had gotten that bad, even in the safest areas of the market, money market funds. The trading of U.S. Treasury bonds. There is an interconnectedness in markets, from the riskiest to the safest, that isn’t often appreciated.
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