Why do we need maturity transformation?

January 12, 2011
responded to the government's report on the subject, as has Blackrock.

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There’s a new flurry of commentary today on money-market funds: the Independent Directors Council has responded to the government’s report on the subject, as has Blackrock.

The problem which needs to be solved here is that money-market funds are in the business of maturity transformation: the funds are instantly available to investors in the funds, but they’re lent out for non-negligible periods of time. As David Merkel says, “financing illiquid assets with liquid liabilities is unstable, and begs for bankruptcy at the first significant loss of confidence.”

Merkel’s solution to the problem — requiring that liabilities match assets — is a simple one, and I like it a lot. If money-market funds promise investors their money back on demand, then they should only lend out money overnight.

How much downside would be associated with eradicating maturity transformation in this way? Not much, says Ashwin Parameswaran, who argues that “structural changes in the economy have drastically reduced and even possibly eliminated the need for society to promote and subsidise maturity transformation”.

I’m inclined to agree with him, since the downside of eliminating maturity transformation is higher interest rates, and a move towards equity and away from debt. Which would be very welcome, and make the economy as a whole much more robust.

This doesn’t mean, of course, that deposit insurance should be abolished. Deposit insurance does indeed act as means to promote maturity transformation, but it also acts to safeguard the savings of people with very little money, and encourage them to move their money out of the mattress and into the banking system.

But when people put their money in uninsured vehicles like money-market funds, they’re effectively trying to get interest rates associated with longer-term investments, on the order of a few weeks, while refusing to lock up their money for any time at all. If they want to make those longer-term investments, they should do so, rather than having their cake and eating it as they do right now.

Maturity transformation has, historically, been a helpful thing in terms of providing credit to grow the economy. But its time might have come and gone. At this point, there’s too much debt, not too little. And requiring assets to match liabilities would help move us back to a healthier state.


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