In the case of a floating rate NAV, fund managers faced with large redemption requests typically sell their most liquid assets first, leaving the remaining investors with a riskier, less-liquid portfolio and a greater risk of loss. Similarly, with a stable NAV and a capital buffer, unless the capital buffer were very large, there would still be an incentive to run because the buffer might not prove large enough to shield the investor from loss. Because the second option is the only one that actually creates a disincentive to run, as I stated before the FSOC proposal, I view it as the best one for financial stability purposes. The requirement that investors who withdraw funds must maintain a small balance for a short period to absorb near-term losses would deter investors from pulling out at the first glimpse of trouble and make the system safer. The modest withdrawal restrictions, which create a “minimum balance at risk”, might be set at 5 cents on the dollar, based on the high-water mark of recent holdings, with more favorable treatment for small retail investors.15 A minimum balance at risk of loss would also increase market discipline. Corporations and other sophisticated investors would have an incentive to monitor risk-taking more carefully,  13  Financial Stability Oversight Council. 2012. “Proposed Recommendations Regarding Money Market Mutual Fund Reform”. (November). http://www.treasury.gov/initiatives/fsoc/Documents/Proposed% 20Recommendations%20Regarding%20Money%20Market%20Mutual%20Fund%20Reform%20%20November%2013,%202012.pdf  14  See William C. Dudley. 2012. “For Stability’s Sake, Reform Money Funds”. www.bloomberg.com, August 14. http://www.bloomberg.com/news/2012-08-14/for-stability-s-sake-reform-money-funds.html.

This created an incentive for investors to be the first to get out whenever there was any uncertainty over the underlying value of the assets in the fund. By being first in line, they could exit while the fund could still repay at par, leaving others to bear any losses. The longer the investor waited, the greater the risk that the fund would be forced into the fire sale of assets to meet redemptions and end up “breaking the buck”. As the crisis unfolded, the Federal Reserve, the U.S. Treasury and others took a series of actions to contain the spiral of funding runs and asset fire sales. First, the traditional lender of last resort function was strengthened through the introduction of the Term Auction Facility (TAF) and foreign exchange swaps with foreign central banks. Then, as the crisis intensified, lender of last resort liquidity provision was extended to directly backstop key wholesale funding markets and opened to certain nonbank firms. The Federal Reserve created a direct backstop to the tri-party repo system through the Primary Dealer Credit Facility (PDCF). When the Reserve Fund broke the buck after the failure of Lehman Brothers, precipitating a run on money market mutual funds, the Treasury guaranteed money market fund assets and the Fed introduced the Asset-Backed Commercial Paper Money Market Fund Liquidation Facility (AMLF). The Fed also backstopped the commercial paper market (formerly funded in large part by money market mutual funds) by introducing the Commercial Paper Funding Facility (CPFF).