For an asset class with almost $3 trillion in assets, you would think investors would pay more attention to the holdings in their money market funds. We have found little information or analysis on the holdings of money market funds. While your money market mutual fund is certainly safer now than it was in 2007-08, if you think that recent proposals by the Securities and Exchange Commission (SEC) make your fund completely safe, you have not been paying attention.
Since 1999, I have advised friends and family to invest in "treasury-only" money market funds. After reading the following three documents, I find no reason to change that recommendation:
- SEC Money Market Reform Proposed Rules
- Response to Questions Posed by Commissioners Aguilar, Paredes and Gallagher
- Financial Stability Oversight Council 2013 Annual Report
While the SEC proposals are carefully crafted and do appear to solve some of the more troubling issues, they remain incomplete. Let's discuss the interesting points found in the reports and then consider the unresolved issues.
The background information provided in these reports gives us an interesting insight into previous problems within the money market industry. A table on page 23 of the SEC Money Market Reform Proposed Rules report shows that 158 funds needed help from their sponsors to avoid "breaking the buck" before the financial crisis of 2008. When the Reserve Primary fund broke the buck, it lost 95% of its assets in four days. Another 100 funds required sponsor support in 2008. A rough estimate of the amount of support required was over $4 billion. Did you realize how often funds needed support from their sponsors?
Of course, this support was in addition to the Treasury Department's use of the Exchange Stabilization Fund (ESF) to guarantee money fund assets. The brazen use of taxpayer dollars to bail out professional investors (without congressional approval) was so politically questionable that new rules make it impossible to use this tool again. If using the ESF worked so well, why is now prohibited?
An interesting section of the report looks at the proposed use of "NAV buffers" to prevent funds from breaking the buck. This proposal was made by the Financial Stability Oversight Committee (FSOC). It is interesting to note the SEC did not believe the FSOC's 1% buffer was sufficient to cover losses, and the SEC suggested at least a 3% buffer was needed. This is kind of a backdoor insight into how large the SEC thinks credit risk could be at money funds.
There is also an interesting discussion of what is euphemistically called the "slow-moving shareholder." The report states that "heavy redemptions in money market may disproportionately affect slow-moving shareholders..." This should be a major takeaway from this report for any investor who might just be on vacation during a period of financial crisis. You do no want to be the last investor out of a money market fund. Do you know your money market fund's telephone number?
I was encouraged to find there were proposals about improved disclosure for money market funds. These proposals have received less publicity than floating NAV and gates, but could be just as important. Transparency is critical for investment decision makers. The daily disclosure of assets is a very good idea that is long overdue.
Finally, there is a both enlightening and frightening discussion regarding money fund's investments in asset-backed securities (ABSs). It was disclosed that the money funds do not really evaluate the collateral behind each ABS, but instead rely on the often implicit guarantee of the sponsor. Such guarantees are often easy and unneeded in good times, but impossible to enforce when all hell breaks loose. Personally, the opaque nature of ABS has prevented me from buying regular money market funds. While the new rules improve the diversification rules, I remain unsatisfied that I really understand the credit risks of these securities. Moody's and JPMorgan saying something is a AAA-credit isn't ever going to be good enough for me.
A popular ABS that shows up in several money fund balance sheets is Chariot Funding. I assume this is not a financing vehicle leftover from the days of Roman chariots, but I can't be sure. Why? There is absolutely no disclosure about what this entity is. There is nothing in the SEC database. Google searches reveal very little. Who runs this entity? What is the collateral? Most importantly, what exactly are the explicit and implicit guarantees of the sponsor? I am sure that the credit rating agencies call it AAA paper. Quite frankly, I would rather rely on the financial opinions of the tooth fairy. Money market fund reform, without further reform of the credit rating agencies, will not be successful.
The Unresolved Issue
How big was the money market mutual fund problem on Sept. 18, 2008? Until we really understand what happened that day, and what the consequences could have been, how can we decide on the proper course of money market fund regulation? To date, the government -- including the Federal Reserve and the SEC -- has been woefully delinquent in disclosing the facts. The only honest discussion of what happened comes from a mild mannered and thoughtful congressman (video) that one day was a little too truthful on C-Span.
Did $550 billion really leave money funds in a few hours? Could $5.5 trillion have left by the end of the day? Rep. Kanjorski is not a wild-eyed conspiracy theorist, so where did he get those figures? It sounds as if they came directly from Paulson and Bernanke. If the problem was in fact that large, then the proposed reforms are egregiously inadequate. As Rep. Kanjorski says in the video, "We aren't any geniuses in economics or finance, we are representatives of the people."
Disclaimer: Investing 501 is a pair of analysts with over 60 years of professional investment experience. This article was written by Gregg Jahnke, one of our founders. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.