by Don Gould
Money market funds, long the parking place of choice for cash balances, now face two existential challenges. The first is the Fed’s policy of maintaining near-zero interest rates at the short end of the yield curve. When market yields are less than the cost of running a fund, the fund sponsor must eat the difference. Operating even the largest scale money funds costs about 0.20% of assets annually.
With 3-month Treasury bills yielding a mere 0.08%, a fund investing only in T-bills is costing the sponsoring fund company at least 0.13% per year, assuming the fund pays 0.01%, the default yield for many funds these days. (Apparently, paying 0.01% is considered more cosmetically acceptable than paying zero. At 0.01%, your money doubles in about 7,000 years.) Funds investing in bank and corporate obligations may be able to eke out a gross yield that barely exceeds fund expenses, but who would want to own such a low-yielding vehicle? Fewer and fewer, it seems. In the past three years, investors have pulled nearly $1.5 trillion from US money funds, or almost 40% of assets. Numerous fund sponsors have exited the business altogether.
The second threat is regulatory and can be traced back to the September 2008 depths of the financial crisis. The Lehman Brothers bankruptcy caused the Reserve Primary Fund (the oldest money fund and among the largest) to lose about 1.3 cents per share overnight and thereby “break the buck,” i.e., lose its hallowed $1.00 share price. To stem the panic that ensued, the US Treasury temporarily guaranteed all money market funds. New regulations put in place in 2010 forced funds to maintain even higher quality portfolios than before, but the fundamental vulnerability of money funds remained, namely, the risk that bad investments could cause a run on a fund.
The idea of a constant $1.00 share price has been a convenient fiction since the advent of money funds in the early 1970s. In reality, money fund share prices fluctuate daily, but as long as they remain above 0.995, applicable rules permit the fund to round its share price to $1.00 and transact shares at that price, giving the illusion of a risk-free investment. The SEC recently proposed that money funds report and transact at their true share price, be it 0.9984 or 1.0015 or whatever. From a policy standpoint, this is a reasonable proposal, but it would also remove the money funds’ last vestige of cash equivalency, with dire consequences for the money fund business, in our view. When one dollar in is no longer a certain dollar out, the game changes.
The money fund industry rightly argues that most bank assets aren’t nearly as safe or liquid as money fund portfolios. Yet FDIC insurance effectively guarantees a constant $1.00 value on the bank deposit, plus interest, up to $250,000 per depositor. But this misses the key point, which is that the banks have a big, powerful lobby and an even more powerful constituency (depositors) for whom FDIC deposit insurance is sacrosanct. Arguably, the government (and the taxpayer) should not be on the hook for bad decisions by bankers or money fund managers. This is a case where the money funds might win a fairness battle, but will likely lose the political war.