Some Money Market Funds are Taking on More Risk

 

Money market funds are accepting more risk in reaching for better yields only two years after the $62 billion Reserve Primary Fund “broke the buck,” according to a recent Wall Street Journal article by Eleanor Laise, “Money Funds Try Risk Again.” This despite new SEC safety rules requiring that 30% of money fund assets must be invested in assets maturing in seven (7) days. The increasing risk in money market funds is attributable to various factors.

First, the 30% rule has spawned an unintended risk-creating consequence. Companies that issue such short-term debt are apparently issuing less of it, preferring to issue more longer-term debt. As a result, the pool of available investments has contracted, which means less diversification and more risk.
Second, according to the article, money funds’ exposure to the shaky financial sector has increased- 36% percent of money fund holdings are invested in the top 20 corporate issuers, most of them large European banks that are embroiled in the debt crisis over there.

Third, the quality of money market fund investments has deteriorated. A common money fund investment is the repurchase agreement or repo. In the past, they were collateralized by mostly government securities, but lately money funds are accepting riskier corporate debt and stocks as collateral in order to increase the yield. One money fund mentioned in the article, which has the words “U.S. Government” in its name, had about 15% of its assets backed by corporate and municipal debt while claiming that they “were fully collateralized by government securities.”

Moody’s is apparently proposing to scrap its traditional Aaa-denominated ratings and move to a scale from “MF1 to MF4,” depending on factors such as liquidity and potential “parent support” in a crisis.

The director of investments for the Maryland treasurer’s office has reportedly abandoned money funds altogether, and has placed $250 million in a “highly, highly conservative local government investment pool,” whatever that is. Her timing has been good before ? she transferred $300 million from the Reserve Primary fund to the Reserve U.S. Government just weeks before the Lehman bankruptcy.

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