Track the companies that matter to you. It's FREE! Click one of these fan favorites to get started: Apple; Google; Ford.



Money Market Fund Armageddon

Money market funds have long seemed more like bank accounts than the mutual funds they really are. However, such could soon change if reforms proposed by the Securities and Exchange Commission are implemented.

First, it would require institutional funds to adopt a floating net asset value. Current rules allow funds to quote a stable per-share price. Second, it would establish "gates" or redemption fees on institutional funds. The word "institutional," however, is not clearly defined in the proposed regulations.

A real quick history of money market fundsDuring the high inflation and interest rate environment of the 1970s and early 1980s, many banks promoted money market funds. This was in response to customer demand for interest on deposits, which at the time, Regulation Q restricted.

The potential impact of reform
Financial firms that operate money market funds, provide services to competing funds, or that rely on money market funds to purchase their commercial paper could suffer if the proposed reforms were promulgated.

JPMorgan Chase, for example, provides services to 13 outside money market funds, and operates the industry's largest, the JPMorgan Prime Money Market Fund. But from the standpoint of money market fund service provider and operator, JPMorgan is probably alright. The size of these businesses is large but not huge in the context of the overall JPMorgan Chase family of businesses.

The bank, however, is among the largest issuers of commercial paper, 40% of which is held by money market funds. A smaller money market industry could thus force JPMorgan to issue less commercial paper and borrow more from commercial banks. This would dramatically increase the bank's cost of short-term liquidity.

During summer 2012, for example, the spread between commercial bank loans at the prime rate and the best commercial paper rates was about 3.01%.

Don't think that's a lot? Imagine if your credit card company were to suddenly raise your interest rate 1,354.17%. Because that is exactly what could happen to these banks and eventually you, too.) [See chart at right.]

State Street could suffer much the same if reform were implemented. The company "provides various services for 425 money market funds," and 43% of its 2012 revenue was for money market-related services, according to Hoovers. More important, though, State Street, like JPMorgan Chase, was among the 50 largest issuers of short-term, commercial paper last year. Thus, State Street and JPMorgan could suffer the same runaway short-term, liquidity costs. (See chart below.)

The impact of reform on Charles Schwab could be muted. Although the original discount broker is "one of the largest managers of money market fund assets in the United States, with 3 million money market fund accounts and $168 billion in assets under management," 88% of that is in sweep accounts for retail investors. Such would logically seem exempt from the proposed changes.

BlackRock, which manages $192.6 billion in money market fund assets, is a different story. "At year-end 2012, 84% of cash [assets under management] AUM was managed for institutions and 16% for retail and [high net worth] HNW investors." A business mix that would suggest "institutional."

Federated Investors faces a potentially more difficult situation. As of "December 31, 2012, approximately 47% of Federated's total revenue was attributable to money market assets," making the company's business far more money market-centric than its competitors. Although again, exactly how "institutional" gets defined remains an unknown.

The flip side
Money market funds have not always been so profitable. For example, in September 2008, Bank of New York Mellon took "a $425 million third-quarter charge to bail out 10 funds affected by Lehman Bros.' bankruptcy, in a bid to help investors avoid losing money." Such an expense in the future could be far greater.

Immediately after the collapse of Lehman Brothers, the Reserve Primary Fund broke the buck, which begot a run on money market funds. The U.S. Treasury stepped in and guaranteed the "share price of any publicly offered eligible money market mutual funds." Unfortunately, Treasury failed to first secure congressional approval so Congress included a never-again clause about this in its Emergency Economic Stabilization Act of 2008. Therefore, in a future run on money markets, the sponsors themselves would bear the financial brunt of keeping funds from breaking the buck, unless the rules were rewritten now as the SEC has proposed.

More guidance in the market
Millions of Americans have waited on the sidelines since the market meltdown in 2008 and 2009, too scared to invest and put their money at further risk. Yet those who've stayed out of the market have missed out on huge gains and put their financial futures in jeopardy. In our brand-new special report, "Your Essential Guide to Start Investing Today," The Motley Fool's personal finance experts show you why investing is so important and what you need to do to get started. Click here to get your copy today -- it's absolutely free.

Read/Post Comments (0) | Recommend This Article (2)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

Be the first one to comment on this article.

Compare Brokers

Fool Disclosure

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 2710406, ~/Articles/ArticleHandler.aspx, 9/27/2016 11:50:57 AM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...

Today's Market

updated Moments ago Sponsored by:
DOW 18,179.54 84.71 0.47%
S&P 500 2,155.58 9.48 0.44%
NASD 5,288.89 31.40 0.60%

Create My Watchlist

Go to My Watchlist

You don't seem to be following any stocks yet!

Better investing starts with a watchlist. Now you can create a personalized watchlist and get immediate access to the personalized information you need to make successful investing decisions.

Data delayed up to 5 minutes

Related Tickers

9/27/2016 11:35 AM
BLK $361.82 Up +1.12 +0.31%
BlackRock CAPS Rating: ****
FII $29.77 Up +0.05 +0.17%
Federated Investor… CAPS Rating: *****
JPM $66.23 Up +0.45 +0.68%
JPMorgan Chase CAPS Rating: ****
SCHW $30.55 Up +0.09 +0.30%
Charles Schwab CAPS Rating: ****
STT $70.05 Up +0.72 +1.04%
State Street CAPS Rating: *****