Tag: 33-9616

The Stability of Prime Money Market Funds

adoption money

I was critical of the Securities and Exchange Commission’s new rule on money market funds. To me it seemed like it was trying to fix a problem that didn’t exist, and in the process made things more complicated. For criticism to be correct, I need data. After review a paper on the Stability of Prime Money Market Mutual Funds, maybe I was wrong.

Steffanie A. Brady, Ken E. Anadu, and Nathaniel R. Cooper looked at money market funds from 2007 to 2011 for evidence that they could have “broken the buck.” The most famous instance was when the Reserve Primary Fund did the unspeakable in September 2008 because of its exposure to Lehman debt securities.

The authors were looking for instances where money market funds could have broken the buck, but the sponsor stepped in to prop up an ailing fund. Their paper presents a detailed view of the non-contractual support provided by sponsors during the recent financial crisis. They looked at public SEC financial statement filings to find evidence of problems.

They found at least 21 money market funds would have broken the buck without sponsor support during the Great Recession. They found frequent sponsor support during that period with at least $4.4 billion of support to 78 of the 341 funds reviewed.

The largest support relative to a fund’s AUM was the $336.8 million (6.3% of AUM) support for the Russell Money Market Fund.

“On September 14, 2009, the Lehman Securities were purchased by Frank Russell Company from the Fund at amortized cost of $402,764,934 plus accrued interest of $775,756.”

Perhaps money market funds are riskier than I thought. Fund sponsors have repeatedly, voluntarily stepped in to stabilize these funds. The SEC’s rule will make these money market funds less attractive as a safe haven for cash. But maybe they are not really as safe as I thought.

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Money Market Fund Reform Makes My Head Hurt

100 hundred dollar bill

One of the critical moments of the 2008 financial crisis was caused by Lehman Brothers and its effect on the Reserve Fund, a money market fund. The fund had a significant amount of short-term debt issued by Lehman. Enough that the fund had to ‘break the buck.’ Now even “cash” was not a safe place to invest capital.

The Securities and Exchange Commission has been looking at this problem for years and issued final rules yesterday in an attempt to fix the problem.

The first fix is removing the fiction that a money market fund has a share price of $1. Money market funds had an exemption from valuation and could keep a stable net asset value. To appease retail investors, the change only affects institutional class funds.

Second, the SEC granted money market funds the right to impose redemption restrictions. The fund can charge a liquidity fee or suspend redemptions if the fund encounters liquidity problems. The SEC wants to stop any potential bank run like events on money market funds.

I have to admit that I have not finished reading the rule. It’s an 869 page behemoth of a regulatory release.

I’m trying to figure out the implications for cash management operations. A company needs to hold onto a stockpile of cash to help fund future operations. Bank deposits are only insured up to $250,000. Any stockpile bigger than $250,000 was a risk if the bank failed. We have been in a period where bank failure was at the forefront of everyone’s mind.

Dodd-Frank alleviated that concern by granting unlimited protection for non-interest bearing checking accounts. That’s any easy choice. Interest rates are excruciating low for cash deposits. (Fantastically low if you are borrowing.)

That unlimited protection expired at the end of 2012. It was easy to get diversification and reduce exposure to bank failure by putting the cash in a money market fund. There is little interest earned, but the diversification reduces risk.

There are other alternatives to money market funds, but they take more resources to manage, cost more, or carry more risk. In this low interest rate environment there is little gain in trying to more actively manage the cash. Any interest rate gains will be chewed up by transaction costs.

The SEC has made the lives of corporate treasury groups more difficult. I don’t think they feel any safer and I don’t think the financial markets are any safer.

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