A drop in asset prices can snowball into a full-fledged financial crisis. This true of any asset and many market. So, what is so special about Money Market Funds?
Well, for one, it is not as if similar risks in sectors such as banking have been left unattended. There are regulatory efforts on about pro-cyclicality, concentration risks etc. in various sectors.
And yet Money Market Funds have something specific by way of risk. The tightening of money markets is an early sign of possible crises somewhere else in the financial system. When an infrastructure developer, for instance, faces a credit problem, the first attempt at staving off the inevitable is to dip into available liquidity. It does not solve the problem underlying in the business and therefore things tend to worsen.
Money market funds hold a lot of liquidity from institutional clients: financial and non-financial entities.
Recent data shows 33% of money market assets to be held by corporates and 16% by financials (look here). Any distress will cause an outflow of liquidity from money market funds. This will surely serve as an early warning system indicating troubles in those sectors.
So yes, money markets are special, as are money market funds – when it comes to early warning signals.
To leave it unattended would be a mistake and the Money Market Fund Regulation covers that gap cleanly.