RSS Facebook Twitter LinkedIn

Featured Advisor

Kim Butler

Partners for Prosperity, Inc.

City:Mt. Enterprise

State: TX

I have 20+ years of handling alternative investments in cash, growth and income for clients nationwide.  I strive to help my clients with all things financial in every way possible over the phone and the web.  I own an alpaca farm which I enjoy working during my downtime.  I also enjoy gardening, writing and reading books.  I also train other advisors on Prosperity Economics.

Click to see the full profile

Share |

Federal Regulators Want to Make Money Market Funds Even Safer

Money market funds are not as stable as they may appear

Money market funds attract investors who are looking for a safe place to park their cash and earn a little interest, but federal regulators say the funds are not as stable as they appear.

Fresh in mind are memories of the week of Sept. 15, 2008, when investors withdrew $310 billion from money market funds. The sharp selloff of 15 percent of fund assets followed the failure of Lehman Brothers and created a credit crisis halted by emergency measures by the U.S. Treasury. The agency provided temporarily guarantees of money market fund account balances.

Since the near collapse of the financial system the Treasury has worked with the U.S. Securities and Exchange Commission to make money market funds more stable and transparent, but federal regulators say current measures don’t go far enough.

“More needs to be done to better protect money market funds – and the broader financial system – from the destabilizing risk that can result from a broad money market fund run,” said SEC Chairman Mary L. Schapiro, speaking at a special round table held in Washington, D.C. yesterday.

The funds work by pooling money from individual and institutional investors and investing the assets in short-term debt securities. The $3 trillion industry plays an important role in providing credit to businesses, financial firms and government agencies. The funds earn interest while maintaining a net asset value of $1 a share.

Most investors view money market funds as low-risk, easily redeemable investments that earn relatively low returns. They tend to lump them into the same category as bank deposits. In reality, money market funds differ in important ways from bank accounts. Most significantly, the funds are not guaranteed by federal deposit insurance and investors run the risk of losing the money they invest in the funds.

Money market funds gain the appearance of security through their stable net asset value of $1 a share. Federal law, specifically the Investment Company Act of 1940, requires the funds to reprice their shares if the market value of the funds falls more than one-half of 1 percent below the net asset value. The trigger would be a market value of  $0.995 for a $1 share, according to a special report by the President’s Working Group on Financial Markets.

This phenomenon, known as “breaking the buck,” led to the investor flight of 2008. Money market funds remain vulnerable to runs “because shareholders have an incentive to redeem their shares before others do when there is a perception that the fund might suffer a loss,” the Money Market Fund Reform Options Report concludes. “For example, although a stable, rounded $1 NAV (net asset value) fosters an expectation of safety, MMFs (money market funds) are subject to credit, interest-rate, and liquidity risks.”

The report proposes a number of options to increase the stability of money market funds. Key among them is the moving to a floating net asset value.

“A stable NAV has been a key element of the appeal of MMFs to investors, but a stable, rounded NAV also heightens the funds’ vulnerability to runs. Moving to a floating NAV would help remove the perception that MMFs are risk-free and reduce investors’ incentives to redeem shares from distressed funds,” the report concludes.

The report acknowledges that the plan might have “several unintended consequences,” including lower investor demand for money market funds that, in turn, would limit the ability of the funds to provide short-term credit. A floating share value might also motivate investors to shift assets to overseas funds subject to less regulation.  A fluctuating value might make investor behavior less easy to predict.