I find that most investors remember the big events of the 2008 financial crisis—the fall of Lehman Brothers, the bailouts, the housing collapse. But few recall the intricate mechanisms the Federal Reserve built to stop the bleeding. These facilities were surgical tools designed for specific failures within the financial system. One of the most critical, yet often overlooked, was the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility, or AMLF. To understand its importance, we need to revisit the panic that made it necessary.
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The Root of the Problem: A Run on Money Market Funds
The crisis reached a terrifying inflection point in September 2008. The Reserve Primary Fund, a large money market mutual fund (MMMF), “broke the buck.” Its net asset value (NAV) fell below \$1.00 per share due to losses on debt issued by Lehman Brothers. This event was unprecedented for retail investors, who considered these funds as safe as cash.
It triggered a historic run on prime money market funds. Investors, fearing losses, submitted massive redemption requests to get their money out. To meet these requests, fund managers had to sell assets. But the market for those assets—primarily high-quality asset-backed commercial paper (ABCP)—was frozen. No one was buying. This created a vicious cycle: forced selling drove prices down further, increasing the pressure on other funds to also break the buck. The entire short-term credit market, which many corporations rely on for daily operations, was seizing up.
The Fed’s Response: Creating the AMLF
The Federal Reserve launched the AMLF on September 19, 2008. Its purpose was simple but profound: to stop the run on money market funds by unfreezing the market for ABCP.
The facility worked by providing a reliable buyer of last resort for this frozen paper. Here’s how it functioned:
- Eligible Borrowers: The Fed could not lend directly to the money market funds. Instead, the AMLF provided non-recourse loans to U.S. depository institutions and bank holding companies.
- The Transaction: These borrowing institutions would use the cash from the Fed to purchase ABCP from money market mutual funds. The ABCP had to be high-quality, dollar-denominated, and issued by a U.S. issuer.
- The Collateral: The borrowing institution would then pledge this newly purchased ABCP to the Boston Fed as collateral for the loan. The key term is non-recourse. This meant if the borrowing institution defaulted on the loan, the Fed could only claim the ABCP collateral. It could not seek other assets from the institution. The Fed, and thus the taxpayer, was directly taking on the credit risk of the commercial paper.
In essence, the Fed provided liquidity to the banking system with the explicit instruction to use it to buy assets from MMMFs, giving them the cash they desperately needed to meet investor redemptions.
The Mechanics and the Math
The AMLF loan was structured to be unattractive for arbitrage but essential for stability. The loan’s interest rate was tied to the primary credit rate (the discount window rate). The borrowing institution essentially acted as a pass-through; it had no economic incentive to use the facility beyond supporting the system, as the terms were designed to be break-even.
The goal was not to generate profit but to stabilize the net asset value of money market funds. By providing a liquidity backstop, the Fed ensured that funds did not have to engage in fire sales of ABCP. This stopped the downward spiral of falling asset prices and allowed the NAV of funds to stay at \$1.00.
The formula for a fund’s NAV is:
NAV = \frac{\text{Total Assets} - \text{Total Liabilities}}{\text{Total Shares Outstanding}}Without the AMLF, funds were forced to sell assets at a deep discount to meet redemptions. This would reduce Total Assets, causing the NAV to fall below \$1.00. The AMLF allowed them to sell assets at par value, preserving the Total Assets value and maintaining the stable NAV.
The Impact and Legacy of the AMLF
The facility was immediately utilized. At its peak, the AMLF had lent approximately \$150 billion. It was a clear signal that the Fed would not allow the collapse of the money market industry. By providing a functioning market, it halted the run on funds almost immediately. It restored calm and allowed the short-term credit markets to begin functioning again.
However, the AMLF was a product of its time. It was closed on February 1, 2010, as market conditions normalized. Its legacy, however, is permanent. It highlighted a critical vulnerability in the financial system: the structural fragility of money market funds that maintain a stable NAV.
The lessons of the AMLF directly led to significant financial reforms. In 2014, the Securities and Exchange Commission (SEC) implemented new rules for money market funds. These rules were designed to prevent another run:
- Floating NAV: Certain institutional prime money market funds are now required to float their NAV, rather than maintain a constant \$1.00 share price. This acknowledges that the value of the underlying assets can change.
- Liquidity Fees and Redemption Gates: Funds were given the tools to impose fees on redemptions or temporarily suspend withdrawals (gates) during periods of extreme stress. This is designed to discourage a run by making it costly.
A Final Perspective from the Front Lines
As I analyze the tools of the crisis, the AMLF stands out for its targeted precision. It was not a broad-based bailout. It was a specific intervention to plug a specific leak in the financial system’s plumbing. It worked not by injecting endless capital, but by restoring confidence and enabling private markets to function again.
The facility serves as a powerful case study for central banking. It shows the importance of understanding the intricate connections between different financial institutions. The collapse of an investment bank (Lehman) triggered a run on money market funds, which then threatened to cripple corporations that depended on commercial paper to fund payroll and operations. The AMLF understood this chain and broke it.
