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Is Your Cash Really Safe?

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Before last year, nobody thought too much about money market mutual funds. But 2008's cataclysmic events brought the money market industry to the brink of destruction. Amid a recent resurgence of relative calm, the SEC met late last month to discuss the future of money market funds. At issue: what will happen to the fear-induced regulations of 2008, and what rules are appropriate in the somewhat calmer waters of today's markets.

Remembering the good old days
Money market mutual funds, which many people consider risk-free investments, have provided investors with safety, security, and modest income for years. Investing in short-term securities such as Treasury bills and commercial paper, these funds have done their best to keep their net asset value at $1 -- offering institutions a fundamental source of immediate financing while consistently avoiding losses for investors. Safe. Comfortable. Cozy.

Bam! September 2008!
But then came the near-collapse of the U.S. financial system. We all remember those mind-altering September mornings: Lehman Brothers filing for bankruptcy, AIG (NYSE: AIG  ) scrambling to borrow billions of dollars, and an overall wave of panic washing over consumers, investors, and Wall Street alike.

For the first time in 14 years, a money market fund "broke the buck" -- in other words, its net asset value fell to $0.97 a share. That represented an immediate 3% loss on what was traditionally considered an unbreakable investment. Shortly afterward, everyone began jostling frantically to shore up funds. Bank of America (NYSE: BAC  ) , Legg Mason (NYSE: LM  ) , and Wells Fargo's (NYSE: WFC  ) Wachovia all contributed capital to prevent their funds from breaking the buck themselves. Investors started fleeing to the safety of FDIC-insured bank savings accounts.

Here comes the government! We're saved...
Panic comes and goes. Last year, the Treasury Department and the Federal Reserve came swooping in to alleviate the public's concerns. On Sept. 19, the Treasury announced a $50 billion temporary guaranty program for money market funds to reassure investors. The Fed then expanded its emergency lending program to help financial institutions buy asset-backed securities from money market funds, in order to raise cash to pay back shareholders.

Over the past year, things have gotten more or less back to normal. Not necessarily cozy, but secure. The government's on our side. Guaranty programs and lending facilities have kept things quiet in the money market arena. And like most big banks and implicitly guaranteed institutions such as Freddie Mac (NYSE: FRE  ) and Fannie Mae (NYSE: FNM  ) -- the money market industry has suddenly become too big to fail.

Still safe...
By mid-September 2009, however, these guarantees are slated to expire. To help plan for the future, the SEC wants money market funds to behave differently going forward:

  • All money market funds will be required to hold as much as 10% of their assets in securities that can be sold in one day or less.
  • The maximum average maturity of securities held by funds will be cut from 90 days to 60 days.
  • Funds will be allowed to suspend withdrawals should they break the buck, therefore allowing a more orderly liquidation.

So all is good -- right?
Wrong.

  • First, we're still left with the question of whether money market funds should move toward a floating asset value model, or maintain their current stable net asset value model. Two of the biggest players in the industry, Vanguard and BlackRock (NYSE: BLK  ) , have lobbied against the floating formula, expressing fears that investors will move their funds to vehicles that offer a fixed price.
  • Second, money market funds remain heavily reliant on the credit rating agencies, since funds must still buy assets that earn a certain minimum rating. After the financial mess exposed their dubious practices, we now know just how little we can trust such agencies' ratings.
  • Lastly, and most importantly, money market funds will continue to act as "shadow banks" -- implicitly promising the preservation of capital without the supervision or regulation of normal banks. Money market funds are observed by the SEC. On the contrary, banks typically face regulation on multiple fronts from entities including the FDIC, the Federal Reserve, the OCC, and state regulatory agencies.

Given that money market funds continue to claim status as a safe haven for investors, without abiding by the same rules and regulations that banks must obey, how protected do you feel? Let me know by leaving your comments below -- and stay tuned for future coverage.

For related Foolishness:

Fool contributor Jordan DiPietro doesn't own shares of any of the companies mentioned above. In fact, he's broke -- he doesn't own shares of anything. Legg Mason is a Motley Fool Inside Value pick. The Fool also owns shares of Legg Mason and has an incredible disclosure policy.


Read/Post Comments (6) | Recommend This Article (33)

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.

  • Report this Comment On July 07, 2009, at 1:46 PM, FundInsider wrote:

    Cutting back the max maturity from 60 to 90 day would have no impact at all, in the sense that if you hold an investment to 60 or 90 days, you will presumably get back what you expected. The issue is credit risks of the issuers selling those holdings, that's what will break the buck. That will always be a risk in mmkt funds, rating agencies can never be perfect in that regard (even if there is room for improvement).

    As of now the temp guarantee is optional. Fund managers must pay a premium for such insurance and they are not regulated to do so. I say either regulate they all do it (so you spread the risk around and level the playing field) or eliminate it.

  • Report this Comment On July 07, 2009, at 2:27 PM, method13 wrote:

    Great article, but I would recommend all discretionary funds go into equities unless these funds are needed within the next 3 months. I foresee the DJIA increasing to 10,000 by year-end.

  • Report this Comment On July 07, 2009, at 5:00 PM, TMFPhillyDot wrote:

    What are the main indicators or driving factors that lead you to believe the DJIA will be at 10,000 by year end? A 22% increase would be pretty outstanding, especially considering how stagnant the markets have been as of late -- just really curious what your thoughts are -- anyone else share the same sentiment?

  • Report this Comment On July 07, 2009, at 5:35 PM, pardnerincrime wrote:

    I say buy physical silver and gold, in that order, and do it fast while the government in collusion with 2-3 major banks have suppressed and manipulated the PM prices. This may just be your last time to buy under $20/oz. Go for it... nothing else is going to help you keep what you have, and make you some in the future.

  • Report this Comment On July 07, 2009, at 5:36 PM, pardnerincrime wrote:

    Go to www.GATA.org for the real truth on PM market manipulation. You'll be sickened but informed by the truth!

  • Report this Comment On July 07, 2009, at 8:57 PM, pedorrero wrote:

    I with pardnerincrime. I've had a lot of my wealth in gold for years, and to good event. Meanwhile, my retirement funds, over which I have no control, continue to remain in the traditional asset allocation, all kinds of stocks, and "government' paper, ranging from T-bonds to junky business or mortgage debt. This despite the problems of 2008. Or did we learn that Uncle Sugar will continue to come to the resucue? Until, maybe, we find out what is "too big to save?" I'll take another Maple Leaf, thank you very much.

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