How Safe Is Your Money Fund?

09/28/2009 10:30 am EST


Terry Savage

Author, The Savage Truth on Money

How safe is the money in your money market mutual fund? Well, slightly less safe than it was two weeks ago before the US Treasury’s Temporary Guarantee Program for Money Market Mutual Funds was allowed to expire.
You might remember that a year ago, after the Lehman Brothers crisis, the huge Reserve Primary Fund, the “original” money market mutual fund, did the unthinkable: It “broke the buck.” That is, because of losses suffered by the fund on Lehman commercial paper, the value of a share fell below $1.00.

At that point in the global credit crisis, there were fears about a run on all money market mutual funds—the $3.5 trillion in assets, much of which is held in short-term commercial paper. In the midst of that aspect of the crisis, the Treasury stepped in with a guarantee for all existing money market fund assets.

In effect, the Treasury’s action gave money market mutual funds the same guarantee that is carried by bank deposits (within insured limits)—a promise that the government would not allow any losses.

Now the panic is over, and the guarantee has been ended. In fact, the President’s Working Group on Financial Markets is likely to suggest that the $1.00 per share value long held sacred by money market funds be abandoned. In other words, credit would matter! If a fund bought bad paper, the participants would suffer the losses. 

Does that make a difference to you in your search for safety? Maybe, and maybe not. First of all, the Treasury set a precedent with the original guarantee. Markets know the government would step in to avoid a major breakdown in the short-term financing of America’s business. 

That genie is out of the bottle, and it’s called “moral hazard.” The markets know that some banks, maybe even the money fund industry, are now “too big to fail.”  

So, will individual and institutional investors take comfort in precedent and stick with money market funds, without considering the paper they hold?

Or will they head for the safety of those few money market funds that purchase only short-term Treasuries and repos? And will the liquidity of the paper market dry up as worried savers rush back to the safety of Federal Deposit Insurance Corp. (FDIC) guarantees?

As we’ve seen recently, banks are loaded up on liquidity, and loathe to make loans. Without a vital commercial paper market, can the economic recovery continue? The administration might want to think twice about lifting its guarantees and forcing the funds to face the consequence of their paper purchases.

Then again, maybe a little “free market” exposure to risk is just what the system needs to wean itself from its complacent belief that government will always come to the rescue.

You might have an opinion on this topic, and we’d like to hear it. But your actions will speak even louder than your words: Are you planning to move to FDIC-insured deposits, direct purchase of Treasury bills, or Treasury-only money funds—just in case the government is serious about backing out of the guarantee business?

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