Money Market Funds: Run, Don't Walk

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 |  Includes: BAC, C, MINT, WFC
by: Russ Winter

James Grant in a recent Bloomberg interview discussed U.S. Money Market Fund (MMF) exposure to European sovereign and banking debt (at about minute 4 in this video). The effect of zero interest rates is to cause these MMF managers to scour the planet looking for yield to cover fund fees and still have enough left over to pay fund holders a whopping basis point or two. Investors’ and savers’ faith in this strange scheme is unbelievable, as measured by the $2.7 trillion sitting in retail and institutional MMFs. How soon people forget 2008, when MMFs broke the buck and went through a period where investors couldn’t access funds until the Fed rescued them. Now you can be paid 1 or 2 basis points for something similar or worse.

This time around, MMFs have gone abroad, including Europe. I don’t have access to Grant Observer, which requires a $1,000 subscription, but as the interview clip progresses, you can see a graphic showing MMF exposure to Europe. Several of the largest U.S. MMFs are shown. Fitch in its report suggests that MMF exposure to European banks is at roughly 50 percent of total MMF assets. According to the Fidelity site, its big cash reserve (FDRXX) holds 40% in Europe, 30% U.S., 10% Canada, 9% Australia and 6% Japan. After substracting 33 basis points in expenses, it pays on average about 1 basis point: 0.01%. The Fidelity Money Market Portfolio holds 44% Europe, 38% U.S., 8% Canada, 7% Australia, 3% Japan; yield is 1 basis point. This is the background on discount online brokerage Vanguard.

The following is a list of European banks that utilize MMF borrowings. A number of these banks (list of 20 institutions most exposed to Greece here) are directly exposed to Greek and Irish sovereign and bank “restructurings.” You don’t want to be anywhere near these, and you will see them sprinkled throughout the holdings of these MMFs.

I have to admit that I was lulled by the ability to use short term Treasury bills in these brokerage accounts. I have used online brokerages account my whole investing life out of habit. And this coming from a guy who tends to be early on picking up trends. Can you imagine the panic when the Sheeple get wind of the real risk on funds paying them 1 basis point? I smell a run coming on the $2.7 trillion MMF complex.

In my conversations with supervisors at Fidelity and Schwab, they indicated calls from customers are just starting up -- I’m guessing after CNBC and WSJ finally broke the story. You can tell the lower tier call center employees are prompted to refer these calls up the chain to “specialists” who have their rather weak talking points. Once again, no mention on CNBC of the 1 basis point return to retail MMF savers.

Now the four weeks' and three months' T-Bills auctions at Fidelity on new purchases (or rollovers) are sometimes cancelled by Fidelity because of concerns about a negative rate. So the funds are then automatically deposited into the MMF you have elected.

You can also have your cash funds held by one of three too big to fail banks: Bank of America (NYSE:BAC), Citicorp (NYSE:C), or Wells Fargo (NYSE:WFC). Option 4 is Fidelity Cash, all paying 1 basis point. Fidelity Cash is not available in retirement accounts. It also has a tax-free MMF paying 1 basis point. This illustrates the problem: People have been lured into making their funds available for free and for potentially risky situations.

All the major online brokers -- specifically Schwab (MMFs), Fidelity (MMFs) and Vanguard -- now have effectively or potentially closed all the safe options. I haven’t researched or used TD Waterhouse in some time, but suspect the same. If you have a brokerage account, you will need to look into your options and do due diligence. The immediate goal is not to get trapped in one of these European-exposed MMFs.

You can also avoid MMF and TBTF bank money markets by buying a short term brokered CD. Use the Weiss rating system available here to check on banks you can use. Right now, Fidelity offers a three-month CD at 20 basis points from Safra, which Weiss rates B-. Don’t be lazy and go with poor or TBTF banks just because of FDIC. Keep that in mind if it looks like you are trapped.

You can probably do better than that locally in a B or better-rated bank. Check the ratings and usually the bank’s website will give you the rate. Remember that there are restrictions on getting a hold of large quantities of cash in a run. Given that returns are nearly zero, there is a very good argument for holding extra cash and perhaps storing it in a vault. I would tend to use bank money markets because they are accessible and because I believe interest rates will skyrocket because of U.S. credit conditions.

You need to do your own complete due diligence on this as the rules are different for each type of account. For instance, retirement accounts are more restrictive on FDIC-insured MM options (also yielding 1 Bp). You can’t use Schwab Bank in a retirement account either. Retirement accounts -- especially limited-option 401(k)s -- seem prime for being trapped in exposed MMFs. If you are dealing with trust accounts, the situation is even worse. Those will be impossible in a trapped situation if you aren’t prepared.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.