Money market funds are widely perceived as safe, but what happens if they "break the buck?"
Money market funds are widely perceived as stable, but many investors unwittingly take risks when they purchase shares, said Mary Schapiro, chairman of the U.S. Securities and Exchange Commission, in a speech last week pushing for additional reforms of the popular financial product.
Money market funds are mutual funds invested in traditionally stable products, such as bank certificates of deposit, Treasury bills and short-term corporate bonds. The funds are not insured by the federal government, and investors who purchase shares run the risk of losing money. The risks are somewhat camouflaged by a unique feature of money market funds.
Share prices for most mutual funds float and fall with the value of underlying investments – but money market funds work hard to maintain a fixed net asset value of $1 per share. This fixed share is something Schapiro - head of the federal agency charged with ensuring safe and stable financial markets - would like to change. A fixed share price creates the impression that money market funds are safe and liquid investments, said Schapiro, but in reality “A money market fund’s $1.00 stable NAV is brittle.”
Fresh in her mind are the events of 2008 when a $62.5 billion money market fund known as Reserve Primary Fund collapsed, spooking investors who quickly withdrew about $310 billion from money market funds and helped bring global credit markets to a standstill. Emergency measures by the U.S. Treasury and Federal reserves stemmed the run. The SEC imposed stricter rules on money market funds following the crisis, but is now calling for structural reforms.
“Our country should never again be in the position of having to choose between providing support to private market participants, including money-market funds, or risking a breakdown of the broader financial system,” Schapiro said during a speech on Monday at the Securities Industry and Financial Markets Association conference in New York. Schapiro also favors creating a capital buffer to help cushion money market funds.
“Risks remain because, even though every money market fund prospectus says that the fund is not guaranteed and that investors may lose money, investors want, and have come to expect, their dollar – not something shy of that,” said Schapiro. At the first sign the share value is less than $1 – a term known as “breaking the buck” – investors run.
Schapiro’s recommendations meet still opposition from members of the financial services sector who say a floating share price would drastically alter the $2.6 trillion money market funds industry. The Investment Company Institute, or ICI, which tracks the mutual fund industry, argues that changing from a fixed share price to a floating one would not reduce systemic risk in any meaningful way. Rather, it would interfere with the vital flow of money through the financial system by discouraging investment in money market funds.
A floating share price reduces the value of convenience of money market funds to retail investors, said the ICI, and legal constraints would prevent institutional investors from using funds with floating share prices. Surveys show that most investors including 55 percent of institutional cash managers and 72 percent of retail investors - would not invest in money market funds with a floating share price. According to the ICI, “Investors in floating NAV funds face the same incentives to run when markets are under severe stress and investors in stable NAV funds.”