Using short-term borrowing — including zero-term borrowing, like ordinary bank deposits — to fund long-term illiquid assets is a strategy that can go catastrophically wrong.
Mencius Moldbug calls this problematic strategy maturity transformation, because short-term debt is transformed — imperfectly — into long-term debt. In case of panic, the disconnect becomes vivid.
A simple shift away from demand deposits could fix the problem:
If we replaced ordinary bank accounts with money-market mutual funds, then we would no longer have this issue of short-term borrowing going to fund long-term illiquid assets.Instead, the bank’s customers would be equity-holders, and there would be no rush in bad times to run on the bank to get yours before everyone else gets theirs.
The worst-case scenario would be that the fund had to break the buck — unpleasant but not catastrophic.
I’ve said as much before:
Most of these “maturity transformation” issues disappear when you move away from an old-fashioned bank, which makes explicit promises of r% interest and withdrawals on demand, and move to a bond fund, which makes no promises about what yields it can deliver — and which doesn’t have to unwind its investments just because shareholders want to sell their shares.Certainly bad debt can lead a money market fund to break the buck, and that can cause a liquidity crunch for investors who considered it cash-equivalent, but there’s no incentive for a run on the money market fund; shares just lose value, and no new shares are issued until the share price creeps back up to $1.00.
Further, any “maturity transformation” is pretty painless, as those who have cash now can buy shares, and those who want cash now can sell shares. There’s no angst about “fraud” from promising on-demand withdrawals while only holding fractional reserves.
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With no notion of first-come, first-served, a fund’s in no danger of a run; its shares simply drop in value when its assets drop in value. It’s comparatively stable, since no one has an incentive to make matters worse for other investors in order to save their own skin.