This Danger to Your Money Isn't Going Away

Investors take massive risks every day. But the last investments that most investors would think of as being vulnerable to losses are the accounts where they keep their cash.

Recently, though, the SEC has looked closely at one popular place where millions of investors stash their cash. Money market mutual funds don't typically get a lot of press, but they do have a lot of money. Despite concerns over systemic risk that surfaced during the financial crisis four years ago, the SEC chose not to move forward with a vote to make some massive changes to the money market industry. Although many would argue about whether those changes actually would have done more harm than good, what's clear is that whatever risk exists among the funds will remain there at least for the foreseeable future.

The risk
In SEC Chair Mary Schapiro's eyes, the risk involved with money market mutual fund stems from their exposure to corporate debt. Money market funds typically hold short-term commercial paper from a wide variety of corporations. Under ordinary circumstances, the commercial paper is quite safe, and default risks are very low.

Every once in a while, though, a crisis occurs. In 2008, the Reserve Primary Fund suffered big enough losses due to its holdings of Lehman Brothers commercial paper that it had to pass them on to investors after Lehman filed for bankruptcy. Because Lehman's bankruptcy came at such a critical time for the financial system, the resulting loss of confidence eventually led the Treasury to offer temporary insurance protection for money market mutual funds similar to what the FDIC does for bank accounts.

The (proposed) solution
As a result, Schapiro suggested some changes aimed at preventing a future crisis. The new rules would have required a tough choice: either maintaining capital reserves that would have cut the amount available for investment, or allowing fund prices to float. In addition, for fund shareholders trying to liquidate their holdings, the rules would have required a hold-back of a portion of proceeds to prevent preferential treatment in the event of a run on the fund.

But it became clear that Schapiro didn't have the support of her fellow commission members. With pressure from industry members such as Schwab (NYSE: SCHW  ) , Vanguard, and Fidelity, several members of the commission indicated their belief that the changes could cause unintended consequences.

Of the proposals, the floating-price idea would have been the most devastating. It might well have killed off the entire industry, as it would have turned every purchase or sale of fund shares into a taxable event that would have made them far more complicated than they're worth.

The real solution
Leaving aside the fund industry's views, though, investors really shouldn't be concerned about the issue at this point. With most money market mutual funds paying very close to 0% in interest, money market mutual funds aren't a viable place for your money in any event.

Interestingly, even brokerage companies, many of which rely on money market funds for sweep vehicles, are starting to pick up on this trend. At E*TRADE Financial (Nasdaq: ETFC  ) , TD AMERITRADE (NYSE: AMTD  ) , Schwab, and a host of other institutions, affiliated banking units offer FDIC-insured accounts for cash management purposes to brokerage customers. You won't typically get high rates from their banking options, but the FDIC insurance takes away any worries about the commercial-paper market.

Even better are high-yield savings accounts from other institutions. Metlife's (NYSE: MET  ) banking unit, which General Electric's (NYSE: GE  ) GE Capital unit expects to buy out in the near future, offers 0.85% on its insured money market account. A few other institutions offer even better rates. All the rates are low, but the income you earn will be better than the nearly nothing you get from the 0.01% rate of a typical money market mutual fund.

Take care of your money
The government can't regulate away every systemic risk to the financial industry. It's better for you to take your own steps to protect your money. Fortunately, with good alternatives to money market mutual funds, it's easy to sidestep the whole controversy and get your money into safer hands now rather than later.

General Electric had been backing away from the banking business, so its deal with MetLife bank is a bit of a surprise. Find out more about GE's overall strategy in this premium report on General Electric from the Motley Fool. With a year's worth of free updates, you shouldn't miss it.

Fool contributor Dan Caplinger minimizes his money market exposure. He doesn't own shares of the companies mentioned in this article. Motley Fool newsletter services have recommended buying shares of Charles Schwab and TD AMERITRADE, as well as writing puts on TD AMERITRADE. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy helps your money work harder.


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