One of the mainstays of living with a financial plan is holding cash for emergencies, as a backstop to investment income in retirement, and as a highly liquid, risk-free asset class. Assets currently invested in money market funds total about $2.7 trillion. For quite a while, the "assumption" has been that similar to FDIC-insured bank savings deposits, one dollar in a money market fund will always be valued at one dollar. While the interest earned on that one dollar may be beyond miniscule and require a microscope to detect, the dollar would be there nonetheless.
However, during the financial collapse of 2008, Reserve Primary Fund, a $62.5 billion money market fund that had invested heavily in Lehman Bros, imploded as its NAV had fallen to below $1.00, also known as "breaking the buck", with the write-down of short-term Lehman bonds. Reserve Primary Fund was eventually liquidated in Jan 2010, with investors receiving a bit more than $0.98 for every $1.00 of investment. "Breaking the buck" by Reserve Primary Fund caused a wave of fear selling among money market fund investors that froze global credit markets as redemptions caused a flood of selling in short-term assets held by money market funds. For a time, the Feds offered FDIC-style protection for 12 months to stave off a collapse of the money market fund business.
Reserve Primary is not the only money fund to have problems keeping their NAV at $1.00. According to a report published Aug 13, 2012 by the Boston Federal Reserve Bank titled "The Stability of Prime Money Market Funds: Sponsor Support 2007 to 2011," (pdf) from 2007 to 2011 21 money funds requested and received assistance from their management firms to shore up capital preventing them from breaking the buck.
Keep in mind the problem of breaking the buck has not been fully resolved as shown by the 11 instances in 2011 where management firms contributed additional capital to shore up their money market funds. The firms include some of the bigger financial companies, such as Wells Fargo (NYSE:WFC), SEI Investments (NASDAQ:SEIC), ING (NYSE:ING), and T Rowe Price (NASDAQ:TROW).
The SEC has been trying to overhaul the rules for money market funds to allow for a floating NAV that may be worth more or less than $1.00. The managers of money market funds have resisted these changes, proposing their solution of limiting investor withdrawals in times of financial stress. However, based on pushback by Republicans in Congress and money market fund's lobbying efforts, the SEC has delayed since August calling for public comments.
Other regulatory considerations that were voted down by the SEC commissioners included a 1.0% capital buffer with redemption restrictions or maintaining a 3% capital buffer with fewer restrictions.
This week, U.S. Treasury Secretary Geithner announced that as head of the Financial Stability Oversight Council (FSOC) it was sending out for comments a program that incorporates all three of these regulatory options. In addition, Geithner warned that if the SEC and the money market fund industry are unable to agree on reforms, the industry could expect oversight responsibilities shifting from the SEC to the Federal Reserve and the FSOC.
The clock is ticking as the FSOC has announced its own 60-day public comment period. If the SEC wants to regain the oversight responsibility, Geithner indicated three SEC commissioners needed to agree on a reform package.
Keep a close watch on the new tug of war between the SEC and the Treasury Secretary over money market reforms. It seems the Obama Administration is hell-bent on not only destroying the income offered by short-term financial instruments, but also creating the expectation that investor capital may not be protected in money market funds. If the Administration has its way, the one dollar you deposited in a money market fund may only by worth 98 pennies when you try to withdraw it.
All investors should be following this story closely and have a plan for when money market funds can and do "break the buck" with the blessing of the U.S. government.
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