Money Market Mutual Funds Should Continue To Worry Investors

Money market mutual funds, and their ugly step-sister, Stable Value Funds, should continue to worry investors, as they were at the very heart of the sub-prime crisis that caused our financial markets to melt down not once, but three times over the last two years. Paul Volcker, the former Federal Reserve Chairman, was interviewed by Bloomberg News and his comments are very newsworthy. But money-market fund are not a "sexy" segment of the financial markets so the media will likely ignore this article. The talking heads on CNBC, or as I like to refer to them as "Bubble Vision", rarely focus on anything but equities, not realizing the size and breadth of the fixed income and related money markets. As stated in the article, the money-market mutual fund industry has more than $3.5 trillion (yes, trillion with a "T") of assets, and if you add on another $640 billion from Stable Value Funds, you have the makings of a ginormous problem should we have another financial market meltdown without addressing this sector's lack of regulation and imminent liquidity risk to the system.

 

Systemically, money market funds (and to a lesser extent Stable Value Funds) have two separate issues that may prove to be their downfall in a crisis. First of all, the $1 NAV (net asset value) amounts to a free a daily put option for investors in money funds. Because of a lack of regulatory concern, clients (specifically institutional investors) can move money around from money market fund to money market fund to "chase yield" because of the instant daily liquidity of a stable dollar NAV fund at the detriment of longer term investors in the fund. During times of crisis and a flight to quality, the smarter and bigger institutional investors will be the first ones out the door on a money fund in trouble at no cost to them, leaving smaller investors possibly holding the bag should the fund run into liquidity concerns and "break-the-buck".  This is another concern of Volcker's in such that the way the Securities & Exchange Act of 1934 is written, money funds can have their assets marked-to-market at an average price of $99 1/2 and still be worth 100 cents on the dollar, where as bank deposit products do not have this issue. In times of crisis when the smart money has left the fund, those remaining will have assets that are priced below "par" and most probably illiquid (10% bucket of mmkt funds) or longer final maturity (13 months maximum for eligible money fund investments). Will the last one to leave please shut off the lights.

 

Secondly, the independently owned money funds (which happen to be very large per the article) that do not have the benefit of a large bank or financial institution behind them pose a risk for investors. We saw this during the height of the crisis as institutional money moved from non-bank owned money market fund platforms TO bank owned fund platforms, because of the perceptions that banks had the ability to stand behind their funds in the time of crisis. banks have the balance sheet and the ability to go to the Fed should they need to during times of crisis. The one money market fund to break the buck was the Reserve Funds, which were not bank owned. During this same period it is very well documented that the money funds that were part of a national bank actually had cash infused in to the funds by their banks in the form of cash  and or via "lift outs" of impaired assets such as SIVs and sub-prime ABS.

 

I have been intimately involved in the money market arena for the better part of the last 23 years and couldn't agree with Mr. Volcker's concerns more. Should you like to see my background within the specialty of fixed income research, money management, and securities trading, please look at my profile on LinkedIn.

 

 

 

-Jim Claire

 

Managing Partner

 

Firm Mast Guidance, LLP

 

(704) 472-8488