The Effect of the Credit Crunch on the Money Market
- With long-term debt securities, such as bonds, prices may fall below their face value during the term of the securities if issuers' credit risks have increased. But short-term money-market securities most likely don't see their prices breaking the face value because issuers' credit conditions are less likely to deteriorate during relatively short periods. But issuer default can happen in severe credit situations such as a credit crunch. For example, in 2008, Reverse Fund, a money-market fund, saw its investments "break the buck," a term used when money-market investment value drops below the stated face value. The fund held the ill-fated Lehman Brothers' short-term debt, which went into default.
- It's rare that money market securities ever go into default, as issuers most likely first honor their short-term obligations. When certain money-market securities do fail, there is rarely a systematic ripple effect in the money market, contrary to more interconnected capital markets such as the mortgage-securities market. However, during a credit crunch in which credit tightening can potentially affect everyone across the board, the news of one money-market security breaking the buck may cause panic selling among many investors in the money market. Investor selling can put further downward pressure on the money market.
- A credit crunch can also lead to liquidity shortage, making funding difficult for new issuers and increasing their funding costs. As investors become anxious about the safety of their money-market securities holdings and some of them rush to sell, prices of the money-market securities decrease. Without new investors stepping in, any new offers to fund issuers' ongoing liquidity needs have to sell under higher interest or may not find buyers at all, making it unsettling for the otherwise calm and orderly money market.
- Any disruption to the money market negatively affects the economy in the most immediate term when companies are unable to obtain short-term liquidity to fund their ongoing operations such as paying for supplies and payrolls. To stabilize the money market during the credit crunch of 2008, the U.S. Federal Reserve provided various money-market funding facilities, including the commercial-paper funding facility, to inject money into banks and help commercial-paper issuers. With help from the government, money-strapped issuers could continue to meet their debt obligations, reassuring money-market investors in the process.
