Money Market Funds: No Longer Safe

The Market Ticker ^ | 1/2810 | Karl Denninger

[FromLori]

Here's something you won't see talked about much - unless you dig for it.

Zerohedge covered it - the fact that money markets are no longer guaranteed liquid. But look at what The Wall Street Journal had to say:

Money-market funds could be forced to pay out less interest under new federal rules designed to make them sturdier.

With memories still raw from the 2008 meltdown of Reserve Primary Fund, the Securities and Exchange Commission released rules on Wednesday that require funds to hold more liquid and higher-quality assets and disclose the value of their assets per share more frequently.

This makes it sound as though the funds will be safer - and more liquid - right? That is, there will be less risk of what happened when Reserve broke the buck and then threw up gates.

Bloomberg said:

Funds must be able to sell 10 percent of their assets in one day and 30 percent within a week under rules approved today by the Securities and Exchange Commission. The SEC’s 4-1 vote also imposed new restrictions on buying lower-rated securities and required more disclosure on declines in funds’ share prices.

“These rules will take important initial steps toward making money-market funds less vulnerable to runs,” SEC Chairman Mary Schapiro said at a meeting in Washington. “The new rules will have substantial benefits for investors.”

Less vulnerable to runs, eh? That's a rather nuanced statement that at first sounds like "less likely for you to get stuck without access to your money", right?

Well, don't be so sure. Buried in there is this:

Suspension of Redemptions: The new rules permit a money market fund's board of directors to suspend redemptions if the fund is about to break the buck and decides to liquidate the fund (currently the board must request an order from the SEC to suspend redemptions). In the event of a threatened run on the fund, this allows for an orderly liquidation of the portfolio. The fund is now required to notify the Commission prior to relying on this rule.

Formerly the fund had to seek permission to suspend redemptions.

Not any more. Now the fund's board is empowered to do so unilaterally and advise the SEC, as opposed to asking the SEC for permission to toss up the gates.

This is not a small difference folks. Indeed, it is a major problem. You could easily find your so-called "safe" money market fund gated and you unable to get to your money until the fund liquidates - without warning.

So yeah, the funds are now "less vulnerable to runs" as if there's a problem they can immediately bar the door and keep you from leaving with your cash!

That's not quite what you thought that paragraph said, is it?

Many people treat these funds as if they were equivalent to a checking account. Some of the funds will even send you a book of checks!

Investors no longer can reasonably rely on daily liquidity for these funds as a consequence of this change. While under normal conditions daily liquidity remains available it is precisely under abnormal conditions that an investor is likely to most need access to this money instantly, for example to meet a margin call or for other emergency funding requirements.

The inversion of the former rules in this regard means you can no longer treat these as cash equivalents with a higher yield. Indeed, there is damn little reason for anyone to buy these at all now - you're really not any better (or worse) off if you simply deposit the money in Treasury Direct and then buy a ladder of short-term bills - say, 4 or 13-week instruments.

Yes, you'll earn jack doing this. But you're going to earn jack anyway in a money market fund, you won't pay a management fee with a Treasury Direct account, and at least thus far there is no material threat of the US Federal Government throwing up gates.

Inexorably the noose tightens around your neck. Beware.

[FromLori]

ping

[Cold Heat]

They are already worthless. Not much more you can do to make them absolutely useless. You get more satisfaction by putting your money under your bed.

[CharlesWayneCT]

Karl is very illogical here.

First, he complains about getting “less interest” from the money markets, because of new rules that require money market funds to only invest so that they could pay out 10% in a day, and 30% in a week.

Then he complains that they will now have the right to suspend redemptions if otherwise they would have to unload illiquid assets at a loss.

So, which is it? Does Karl think there is some magic wand that would allow a MM fund to invest in long-term assets, but still magically be able to sell those assets at face value if everybody wanted their money back?

THe reality is that, if everybody wanted their money from ANY money market in a single day, that MM fund would not be able to pay out without a big loss.

The new rules make it less likely to have a run, because people will know the MM is invested in a way that would allow 10% sale in a day. And if more than 10% come to get their money, the MM fund doesn’t have to run to government to get a freeze, and you know they can get 30% within the week.

None of this makes MM “less safe”.

[OrioleFan]

I always heard, if you see the NAV for a Money Market Fund drop to 99 cents, you should dump a bunch of money into it to get a gain when it goes back to $1/share (typically a 1 day gain). Is that still true?

[April Lexington]

No. Karl is spot on. Money Market funds are not banks and there is no Federal Reserve System backing them up. If they break the buck, you lose money. If they can refuse to redeem, you are at huge risk. I think these things are dangerous. But, think of how much $$$ sweeps into these things each night! I’d take precaution if I were you...

[CharlesWayneCT]

Neither of your two statements deal with what I said, so they are not a refutation of my argument in support of Karl's position.

Further, there are two types of money market accounts; Money Market funds, and Money Market Deposit Accounts. The funds (mutual funds) are not insured by the FDIC, but the deposit accounts are:

You are probably familiar with the traditional types of bank accounts - checking, savings, trust, certificates of deposit (CDs), and IRA retirement accounts - that are insured by the FDIC. Banks also may offer what is called a money market deposit account, which earns interest at a rate set by the bank and usually limits the customer to a certain number of transactions within a stated time period. All of these types of accounts generally are insured by the FDIC up to the legal limit of $250,000 and sometimes even more for special kinds of accounts or ownership categories.

...

Or your funds may be invested in a money market mutual fund, which may invest in short-term CDs or securities such as Treasury bills and government or corporate bonds. Do not confuse a money market mutual fund with an FDIC-insured money market deposit account (described earlier), which earns interest in an amount determined by, and paid by, the financial institution where your funds are deposited.

For a year, the government actually insured money market funds, but that stopped last September -- and isn't what Karl was writing about here.

My point was not that they aren't dangerous, but that they aren't any more dangerous than they were before, and that the new rules actually make it more likely you can get your money out without breaking the bank.

They could never redeem things for you if they didn't have the money -- it's not like they could print money. Under the new rules, they have to have more investments they can liquidate without loss in a short period of time.

And when they did have trouble, they could get permission to not redeem; the chance simply says they don't have to run to the government first, which wasn't a problem in 2008 for them to do.

So again, I think the rules about liquidity of investments will make things safer.

The problem is that it will reduce the returns, since safer, more redeemable investments cost less.

[April Lexington]

In the olden days (last month) money market mutual funds... the kind that hold short term paper and act like checking accounts but aren’t bank money market deposit funds because they are sponsored by and managed by registered investment advisors like Fidelity, et al.... those funds.... Well, in the olden days, the IA thought long and hard about breaking the buck because it would bring down a tone of bricks on his head and cost him his job. Today, the IA can, through its board of directors unilaterally and without SEC notification refuse to redeem. Now... if you wantr to believe that this change is a distinction without a difference, well... go ahead. I know, given human nature, that the little guy is about to take it in the shorts (as usual). So... you buyz yur funds and you takes yur chances...

[CharlesWayneCT]

They broke the buck in 2008. The fear is already the reality. These rules are intended to make the need less likely. They may not help, but they don’t make it worse.

Karl complained that the rules would lower yields, and make the investments less safe. That is contradictory.

[April Lexington]

Karl complained that the rules would lower yields, and make the investments less safe. That is contradictory.

I'm not so sure. I haven't a clue as to what my sweep account is paying right now. But if these IAs can cut the rate and then decide not to pay out for a period of time, we could get caught in just such a situation. I'm very concerned about the safety of the money market funds right now...