Of all the outrages endured during the financial crisis, perhaps the most perplexing involved money-market mutual funds. In an example of moral hazard writ large, this uninsured risk instrument — with $2.57 trillion in assets — somehow became too big to fail. Five years later, the Securities and Exchange Commission is finally taking steps to address this.

Money-market funds invest in a variety of short-term securities whose values fluctuate. You know, kinda like everything else that trades on a market. However, the funds’ net asset value, and thus the share price, was always $1, regardless of what the underlying assets were really worth.

This is quite bluntly, a fraud, with a couple of twists. First, the true value of these funds was almost never exactly $1, as credit markets moved up and down.

The second part of the charade is that these fund companies were making an implicit guarantee that they would stand behind an investor’s account — until they couldn’t.

Continues here



Category: Mutual Funds, Really, really bad calls, Regulation

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

8 Responses to “Free Lunch Over for Money-Market Funds”

  1. rd says:

    This was the most baffling part of the financial crisis to me. When the Reserve Primary Fund announced that it would break the buck causing newspaper headlines and huge distress in the financial community, I was very confused because it was obvious that they had been buying less safe securities in order to get higher interest rates and therefore it was obvious that they had a chance of dropping a bit below par. I had always held any cash in brokerage accounts in government-backed securities MM funds because I viewed them as safer in a crisis and as a result, they did usually generate less interest than some of the other alternatives.

    Being an unsophisticated investor, I had clearly foregone the opportunity for some additional income over the years by not realizing that the additional interest actually came with zero additional risk because the financial system had thus decreed it to be so. I wish I had understood risk management as well as the financial system gurus.

  2. catclub says:

    The most baffling part now is that the yield on MM funds is approximately 0.01%/yr
    and (insured) bank deposits yield about the same – with zero actual risk up to $250k.

    For small investors Kasasa accounts at credit unions yield 3% on up to $25k. Also insured up to $250k.
    Would you pick up $750 off the ground? I did.

    I think that the Kasasa account benefits from debit card charges to merchants, since they require a certain number per month – but that is not a problem for me.

  3. There is no financial asset that deserves a guarantee. MMFs & MMMFs are a good place to start. Insurance and annuities are a good place to look next.

    In that vein, how is that JD Mellberg firm allowed to run the commercials they run on CNBC? Not only is that trash an explicit violation of compliance regulations, but it also has the mouthfeel of a Jordan Belfort cheap sales pitch!

  4. jritzema says:

    Here is a very interesting research piece by the Boston Fed about sponser support provided to money market funds so they wouldn’t break the buck. It shows how often it was happening and not just in 4Q08-1Q09


  5. DeDude says:

    How about something that would actually stop the panic. If the MM fund breaks the buck, the payback on any withdrawal will be 90% (or twice the estimated shortfall, whatever is greatest). You want to withdraw 100K you get 90K in cash. Then the panic itself would quickly restore the value of the fund to above the buck. If the fund stay below the buck for over 3 business days the value of all accounts are reduced to match their value with the available assets.

  6. Porsche87 says:

    From what I can recall, my 401k’s have never had a cash option. A money market account was the sweep account for all new money or unallocated funds. That’s probably because they don’t have any other way to get their management fees if there was a real cash account. So let’s see, 2007, my 401k money market account is about to break a buck,,,what to do…move my funds to a plummeting stock fund, a plummeting bond fund, pull it out with a 10% penalty plus taxes…what to do? Until the SEC requires 401k’s to have a cash only option, propping up money market funds seems like the right thing to do.

  7. ch says:

    Barry – you say in your article that money market funds are not backed by the government, but hasn’t that been proved empirically false by events in 2008?

    And speaking of frauds – when was “mark to market” reinstated after being suspended in 2009, allowing banks to mark assets to whatever they felt like?

    • Blissex says:

      «And speaking of frauds – when was “mark to market” reinstated after being suspended in 2009, allowing banks to mark assets to whatever they felt like?»

      Very funny! And when were the trillions of toxic assets held by the central bank in various vehicles audited? :-)

      Your question points at the core economic policy driven by central banks and governments and grateful property owning voters in most anglo-american culture countries since 1980: the “sunny uplands” of the *debt-collateral spiral*.

      The debt-collateral spiral is based on the not-so-new idea that asset purchases can be financed by using the asset being purchased as collateral, extended to very high leverage ratios, and to borrowing against already-purchased assets.

      This means that asset buyers can bid up asset prices by using debt financing, higher asset prices result in higher collateral valuations, and these justify even more debt financing.

      Higher debt to buy assets pushes up the valuation of the same assets used a collateral, justifying even higher debt, both to bid asset prices higher and to cash-in the capital gains thus created.

      This mechanism has made many asset owners much richer, and many executives of banks very wealthy.

      The debt-collateral spiral works as long as collateral valuations are never marked down and central banks supply unlimited zero-cost “liquidity” where nobody else would lend it to insolvent banks who don’t formally go bankrupt because they don’t have to mark down to market their collateral, and fiscal policy squeezes the cost of doing so out of the poor and unemployed to offset the inflationary pressure that creates. That’s the Japanese solution, and can take many decades.