Money Market Funds “Feeling the Heat”


Another asset class is “feeling the heat” of the unstable investment market. The historically reliable asset class of money funds has been hit by the financial crisis, providing minimal yields, at best. The money fund, typically investing in short-term, high-grade IOUs, was once considered “a pillar of safety.” In the past, even if the fund invested in commercial paper, it would only do so in extremely creditworthy corporations, thereby preserving an investors’ principal and paying interest, minus expenses, by investing in highly rated securities. Recent practices of money funds have left investors questioning the integrity of and regulators debating an overhaul of these funds.

The Reserve Primary Fund, the nation’s oldest money-market fund, became only the second fund in history that “broke the buck” or whose prices dropped below $1 a share. The Reserve Primary Fund invested in securities issued by the now defunct Lehman Brothers. When worried investors sent in redemption orders to the Reserve Primary Fund, the Reserve Primary Fund didn’t have enough capital on reserve to buy out these holdings. In a January article published on Bloomberg, “JP Morgan’s Staley Calls Money Funds ‘Systemic Risk,” James Staley, head of JP Morgan Chase & Co.’s investment unit, stated that he believes it was the money funds that brought down Lehman and Bear Stearns, as the funds were forced to pull their money from these firms when they saw signs of trouble. When investments in money market funds dry up, it often leads to a freeze in the commercial paper market, thereby cutting off a vital source of short-term capital for the U.S. government and thousands of companies.

The Reserve Primary Fund was not the only fund to encounter trouble. Since the credit crisis began in 2007, companies including Dreyfus, Columbia, Northern Trust, HSBC, Legg Mason, Wells Fargo, SEI, Allianz Dresdner, Bank of America, and Evergreen have all bought up their money funds’ bad investments.

These funds are now facing fee pressure due to the lower yields. According to John Waggoner’s column, “What’s in store for money funds,” published in USA Today on January 30, 2009, the fund companies are having a difficult time keeping the share price at $1. The Fed’s cutting of interest rates to exceedingly low rates has taken its toll on the funds. If the fund only earns 0.1% interest, yet has 0.4% in fees, it cannot keep its share price at $1.

Money funds that traditionally invested in the high-quality, “safer” securities began chasing yields?creating several problems including bad investments low liquidity, and low rates. As investors began to question the integrity of these funds, the government instituted a temporary insurance program to reassure investors that the money funds were safe. This insurance program is due to expire on April 30, 2009, and regulators are still trying to determine the best way to fix the industry.

Currently, the money market funds are providing the capital for many institutions, with over $3.9 trillion lent to the U.S. government, major banks, and giant corporations. Regulators need to find a balance between over-regulating (which could cripple an essential component of the nation’s financial system) and doing too little (leading to an exodus from money funds and thereby prolonging the current credit “crisis”).

The “Group of Thirty”, an independent policy organization led by Paul Volcker, proposed new regulations that would either force the money funds to accept banking-industry controls or give up the accounting rules they currently use. Essentially, money funds that adopted these new proposed standards would become “specialized banks.” They would have access to government insurance and access to the Federal Reserve’s emergency lending facilities, but have to pay capital charges associated with the banking business. Those that opted not to become specialized banks would not be allowed to use the amortized accounting standard that allows the funds to maintain a stable $1-a-share net asset value.

The Investment Company Institute (ICI) opposes this plan. The ICI believes that following the “advice of the Group of Thirty would drive investors to banks from funds. The ICI is set to release its own report and recommendations in response to the “Group of Thirty’s” proposal. Peter Crane, president of Crane Data, LLC, also disagrees with the Group of Thirty, and believes that the money market industry would fight the new regulations “tooth and nail.”

With questions as to the possible yield and regulation of the money funds, investors may be looking to invest in at CDs or short-term funds. With a bank CD, one may receive FDIC insurance and higher yields. Alternatively, short-term government bonds are an option with slightly higher risk.

Page Perry is an Atlanta-based law firm with over 125 years collective experience representing investors in securities-related litigation and arbitration. While past results are not indicative of future success, Page Perry’s attorneys have recovered over $1,000,000 for clients on more than 30 occasions, and have aided clients who have been the victims of financial adviser abuse, unsuitable recommendations, and scams. Page Perry’s attorneys are actively involved in counseling institutional and individual investors regarding their investment problems. For further information, please contact us.