Are Your Money Market Funds At Risk?

You are probably used to seeing your money market mutual fund share price stay at $1 per share. Steady as a rock….right?
Well, that could change – big time. The SEC recently voted to force certain money market mutual funds to float their share prices rather than maintain a constant $1 a share price. That means the money market mutual fund share price could be more or less than $1 a share on any given day.

The changes in the law also allow a fund’s board to disallow redemptions for up to 10 days if the fund’s liquidity drops below 30%. Alternatively, the fund may decide to charge 2% to redeem shares. What?

This is a huge deal for investors who are used to parking money in their money market as a safe harbor. If your money market fund’s price starts floating up and down, that safe harbor sinks. Is this something you should be concerned about? Let’s take a closer look.

Background

Mutual fund prices are determined by the value of the securities held by those funds. That’s true for equity funds, balanced funds, fixed income funds and yes…..money market funds as well. But unlike other mutual funds, money market funds have kept their share price at $1 per share artificially for a very long time and that $1 per share price has been upheld almost universally across the board.

Why is a stable $1 per share important?

The companies that manage these funds like to keep the price at $1 per share because they want to provide stability for investors. In the past, the fund company itself stood behind the $1 per share price. If you redeemed shares (made a withdrawal from the money market mutual fund) when the real value behind the money market was less than $1 per share, the fund made up the difference…probably without you even realizing it. If the value was above $1, they pocketed the difference. Don’t worry, this was done above board and completely spelled out in the fund prospectus.

But there is a problem. The securities held in the money market go up and down in value so that $1 per share price is artificial as I said. Let’s say the fund manager losses a lot of money and the real value of the money market falls to $.90 per share. Once investors get wind of these big losses they make a run for their money. They want to get out of that fund before the share price drops even further. Soon lots of investors make a dash for the exit and then the fund company itself gets in trouble. That’s because when too many investors want their money at the same time, the fund can find itself without the necessary liquidity to repay them.

If that happens, panic ensues. Investors worry about other mutual fund money markets and the entire industry comes under a lot of pressure. This is exactly what happened not long ago.

In 2008, people expected their money market funds to be secure but Lehman Brothers lost too much money to maintain that stable price of $1 per share. The fund value fell to $.97 and sparked a global run on money markets and a threat to the entire world-wide financial system.
Investors yanked over $300 billion out of the money market funds in a week and that stopped global financing dead in its tracks. That in turn pushed the world economies closer to the edge. This wasn’t the root cause of the financial collapse of 2008 by any means. But it made a bad situation far worse.

The SEC figures that if it forces certain money funds to float their prices to reflect the true underlying value of the securities backing up the fund real-time, investors will get used to slight price fluctuations. That way, they won’t be shocked into starting a run on the bank if things turn south.

Who Does This Impact And When Does The Law Go Into Effect?

The new rules are going to kick in 2 years from now and they’ll affect institutional prime and municipal money market mutual funds. According to the ICI, this will impact about 35% of the money market funds available and mostly be an issue for large institutional investors. At least that’s what the SEC thinks.

What You Should Do

First of all, these rules aren’t going to kick in for a couple of years like I mentioned so you can remain calm. You have plenty of time to strategize.

Next, understand that these rules are only going to impact those funds designated as “prime” money market mutual funds and municipal money market funds. If your money market fund has the word “prime” or “primary” in it, you might want to find out if there are other alternatives. The same thing goes for funds with the word “municipal” in it.

And to make sure, talk to your custodian. Find out if the fund you are using falls under these new regulations once they take effect. A simple call should do the trick. If you determine that your fund does fall under these new laws, look for an alternative that does not.

I’m not even sure if this law will stand the test of time or if it will even be implemented. But if it is put in place it will probably be expanded to include all money market mutual funds. If that happens, you won’t have much choice. You will have to learn to live with it. But don’t worry. I have a few ideas on how to cope with that situation as well. For now, let’s not worry about it since it’s not the case.

Do you think this change in the law is a good or bad idea? Why?