Is Your 'Safe' Money Market Floating on Quicksand?
In all of the market reforms since the crash of 2008, money market funds are the one sector that has been virtually untouched despite the blame they got for bringing markets to a standstill. SEC chairwoman Mary Schapiro called it her “unfinished business” last week.
Investors big and small have trillions of dollars in the funds, whose core holdings include short-term bank debt. Investors stayed with the funds even after one venerable firm 'broke the buck" in 2008.
It was the rarest of financial events, a fund failing to make good on its promise to repay the net asset value at $1 for each dollar invested.
That failure came because Reserve Primary, a pioneer in the funds business, was stuffed with too much of bankrupt Lehman Brothers' debt and it could not meet redemption calls when Lehman stopped paying. Since funds invest heavily in bank paper, Europe's woes are causing new fear. Moody's last week downgraded 15 major banks including Citigroup, JP Morgan , Bank of America, Goldman Sachs and Morgan Stanley, striking another blow for funds that buy their debt. Regulators cited these concerns last week as they warned thar money markets are still courting danger and something must be done to avoid another run.
So why do investors and advisers act as if it’s business as usual? If anything, they complain that the funds are too boring, not too risky. To be fair, the funds remain one of the few stable assets in a volatile investment world. They've weathered the U.S. budget showdown, the downgrade of American debt and the historic stock market swoon of 2009 market. The buck is still the buck for money-market investors. None has failed to do so since 2008. (Even Reserve repaid 99 cents!)
But are there dangers lurking beneath the surface? Absolutely, SEC's Schapiro said last week that there have been 300 cases when funds needed help, even if Reserve was one of only two that actually broke the buck in the last 40 years.
Are regulators just crying wolf?
“The truth is that money markets are extremely safe for individual investors,” said Mark S. Germain, money manager and founder of Beacon Wealth Management. “If there were signs of trouble in the markets, people’s funds holdings are very short-term and there would be plenty of time to act.”
Fund data show that money markets make up an ever-smaller piece of portfolios, as other income investments have soared in popularity. Money-market fund managers, chastened by the Reserve fund buck flop and warned by regulators, have become increasingly conservative, turning heavily to low-yield treasurys. They are now too low to attract much attention even in the current low-yield environment.
To be sure, many investors are still exposed to money-market problems, and many are not aware of the risks. The cash portion of millions of retirement accounts is swept into money markets. The Investment Company Institute (ICI)estimated that 19 percent of all business cash is held in the funds.
Those are big numbers, but they are falling. Outside of the financial business, that cash level is half what it was in 2008.
Moving Up Income Ladder
Investors have steadily moved their money up the ladder to higher-yielding fixed-income alternatives. Short-term bond funds, in particular have attracted a huge following. Even as bond yields in general fall, they offer far better payouts than the fractions of a percent paid by money markets.
“Money-market funds are are not as important as they were back then,” said Germain, referring to the 2008 downfall. “We tell people to keep just 1 or 2 percent in money market funds.”
It's easier than ever to find alternatives for storing cash in highly liquid investments that can be quickly liquidated without big risk of capital loss. Short-duration bond funds, income ETFs , TIP funds and floating rate funds are on Germain’s list of alternatives.
The Appeal of Money Market Funds
So why even bother with the microscopic yields of money-market funds that barely top insured bank deposits?
The answer comes from regulators themselves. The funds are a critical component in making the economy work for investors and lenders alike. They are like a money mill that each day churns through billions in short-term debt issued by governments, banks and agencies, turning them into securities that investors can digest.
By guaranteeing that each package they sell is worth a "buck," money markets are providing a virtual currency for market participants. The funds can be withdrawn on demand, more easily than banks release deposit funds. They provide quick capital for money managers and individuals trying to transact business.
Because they play such a pivotal role, regulators believe that the funds must reduce the risk of failure. They must either drop the "dollar" guarantee or create a deposit cushion to guarantee that funds are there in the event of mass withdrawals. The fund industry says either solution would raise costs in an industry already so strapped it has stopped charging traditional user fees. Dozens of funds have closed.
What should consumers care about the industry? Ask Federal Reserve Chairman Ben Bernanke. "Part of the reason that investors invest in money-market funds is that they think that they are 100 percent safe," he told Congress recently. "If that is not true, then we have to make sure that investors are aware and that we take whatever actions are necessary to protect their investments."