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Joe Barbieri has Bachelors' degrees in both Civil Engineering and Commerce from the University of Toronto. He has worked in the Financial Services field for over 13 years, with over 10 years on the institutional side of the business. He has covered positions from Fund Accounting to Investment... More
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  • How Do The Changes To The Money Market Fund Rules Affect You? 0 comments
    Aug 6, 2014 11:46 AM

    During the crisis of 2008, there was a selloff on some money market funds in the U.S. that caused their prices to trade below their fixed cost of $1 per unit. (1)(2)(3) This phenomenon is known as "breaking the buck". Note that in Canada, many funds are priced at $10 per unit, but the principle of a fixed cost remains the same. Only one firm called "Reserve Primary Fund" actually broke the buck when its units were selling for 97 cents on the dollar during 2008. However, there were many other firms that were apparently close to having this happen to them at the same time. (4) The only reason why nobody has heard about this is because the government bailed out these firms to prevent a total catastrophe.

    What does this mean really? Breaking the buck means investing $1 in a money market fund and getting less than one dollar in return. Selling your money market fund at less than a dollar means that you are taking losses on a very safe investment. This is like a bankruptcy proceeding where you the creditor are receiving less than you put into the investment in return. This can also become a money market fund version of a bank run, where the money invested is not considered safe, causing people to redeem their units and threaten the solvency of the bank.

    Fast forward to 2014 and the regulators are trying to prevent this from happening again. (5) They are proposing having the unit price fluctuate to better reflect the value of the investments in a money market fund. This fluctuation would only be allowed on non-government securities, so most typical money market funds would not be affected by the new rules. Since anything that changes in price may trigger a capital gain or loss, there would be tax implications for these price fluctuations which would only be considered once a year instead of on every trade. These rule changes are intended more for institutional investors because they will buy money market funds that contain riskier securities like commercial paper. The Board of Directors of money market funds is allowed to temporarily suspend withdrawals or charge exit fees for people who are trying to sell their fund.

    What impact can these new rules have? Investors will begin to favour government securities over other investments should a crisis hit. If it does happen, the loss of trust in non-government securities can linger on for years, causing a wider premium to be charged for holding these investments. Exit and withdrawal fees are a deterrent for investors as they penalize depositors for the woes of the money market fund. The underlying issue here is: how can trust in financial institutions be maintained given how vulnerable they are to crises from interdependence? It was the Lehman Brothers bankruptcy that triggered the breaking of the buck and the 2008 meltdown. Whether these new rules can actually prevent a second 2008 style crisis remains to be seen.

    Sources:

    1) http://www.bloomberg.com/article/2014-07-23/aDgWPYJ_h.KQ.html

    2) http://www.marketwatch.com/story/money-market-fund-breaks-the-buck-freezes-redemptions

    3) http://www.bloomberg.com/news/2013-09-14/firm-that-broke-the-buck-in-2008-fails-to-reach-sec-deal.html

    4) http://libertystreeteconomics.newyorkfed.org/2013/10/twenty-eight-money-market-funds-that-could-have-broken-the-buck-new-data-on-losses-during-the-2008-c.html

    5) http://www.bloomberg.com/news/2014-07-22/money-funds-get-new-restrictions-aimed-at-preventing-runs.html

    Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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