Taking a Close Look at Money Market Funds

Money market funds are in the news again. Since their development in the 1970s, money market funds were considered ultra-safe places to store cash. Most investors considered them to be like cash that pays interest. Their net asset values always were $1.00. That changed in 2008 when the Reserve money market funds revealed they owned a large amount of Lehman Brothers debt. Lehman Brothers filed for bankruptcy liquidation, and the debt was worthless or close to it. This triggered a panic in money market funds across the country. Things calmed down when Congress said the federal government would guarantee most money market funds and the economy stabilized.

Now, the fears are back. Money market funds struggled the last few years. The Federal Reserve kept short-term interest rates low, so low that the yields on the debt money market funds purchased didn’t cover their expenses or left investors with little or no income after expenses. A number of money market funds closed their doors or closed to new investors.

To boost yields, many money market funds purchased debt of European banks. There’s apparently no one dumber than a European banker. They loaded up on the various U.S. mortgage securities during the bubble (see The Big Short by Michael Lewis). The last few years they loaded up on securities of the banks of the European creditor countries. These banks in turn made loans to the debtor European countries (Greece, Italy, Ireland, Spain, and Portugal). If one of more of these countries default on their loans, the banks will suffer. If the governments don’t bail out the banks, the money market funds will suffer.

U.S. money funds eligible to buy corporate debt had about $800 billion, or half their assets as of May 31, in securities issued by European banks, Fitch Ratings estimated. European lenders held more than $2 trillion at year-end in loans to Greece, Portugal, Ireland, Spain and Italy, the most indebted European countries, the Bank of International Settlements estimated.

“It’s not about whether Greece defaults, it’s what happens after that, and there’s uncertainty behind that,” Alex Roever, head of short-term fixed-income strategy at JPMorgan Chase & Co. (JPM) in New York, said in a telephone interview.

To protect yourself and your cash, put short-term cash in insured certificates of deposit or money market funds that invest only in U.S. Treasury securities. Later, I’ll have a post with another option to earn higher yields and still keep your money safe.