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Money Market Funds and Financial Stability: Comparing Sweden to the U.S. and Iceland

Journal 32: Applied Finance

Gudrun Gunnarsdottir, Maria Strömqvist

The financial crisis, in particular the collapse of Lehman Brothers, has revealed that money market funds are more risky than had previously been believed. We discuss the importance of money market funds for financial stability and whether situations similar to those during the recent crisis in the U.S. and Icelandic markets could arise in Sweden. We find that there are similarities between the Swedish and Icelandic funds, but few similarities with the U.S. funds. In Sweden, as was the case in Iceland, the assets under management are concentrated in a few funds and the connection to the major banks is strong.

However, given the relatively small size of the money market funds in Sweden, we do not find that they, in isolation, are of major systemic importance as a source of funding for the Swedish banks. The funds are more likely to have a systemic impact through spill-over effects on the banking system, especially in a market already characterized by high uncertainty and risk aversion. The money market funds are thus more important to certain parts of the financial market, such as the market for corporate commercial paper and covered bonds.

As the recent financial crisis has shown, in certain situations money market funds can be considered important for financial stability. These situations are characterized by extensive uncertainty and instability in the markets. The money market funds in both the U.S. and Iceland were severely affected by the recent financial crisis. This paper discusses the importance of money market funds for financial stability and whether situations similar to those during the recent crisis in the U.S. and Icelandic markets could arise in Sweden. Do the Swedish money market funds have significant similarities to the U.S. and Icelandic money market funds?

Factors that influence the importance of money market funds, apart from the market situation, include the risk of spill-over effects to the banking system, investor sentiment, and whether the funds are an important source of funding for banks and mortgage institutions. This paper examines the importance of these factors for the Swedish money market funds.

Data has been collected from several different sources for 2003 to the third quarter of 2009. Data at the aggregate level has been collected from the Swedish Investment Fund Association (Fondbolagen), Statistics Sweden, and Morningstar. To analyze specific holdings, we examined the portfolios of seven large money market funds. The data on individual funds was collected from the Swedish Financial Supervisory Authority (Finansinspektionen), the funds’ annual and semi-annual reports, and from the fund companies themselves. The paper focuses on money market funds mainly investing in securities issued in domestic currency. For the Swedish and Icelandic markets, money market funds are defined as short-term bond funds with an average maturity of less than one year. The corresponding definition for U.S. money market funds is 90 days. Differences in definitions will be discussed later in the paper.

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