Money Market Funds: Stable—Until They're Not

Securities and Exchange Commission Chairman Mary Schapiro testifies before the Senate Banking, Housing and Urban Affairs Committee on Capitol Hill. Photograph by Chip Somodevilla/Getty Images

Mary Schapiro, chairman of the Securities and Exchange Commission, lost her battle on Aug. 22 to change how money market funds are regulated. Such companies as Vanguard Group and Fidelity call the funds “one of the most conservative investment options offered” and say they “represent one of the safest types of mutual funds.” Schapiro terms the claim of stability utter “fiction.” In defeat, she called on other federal regulators to pick up where she left off.

So who’s right? And what exactly goes on behind the scenes at money market funds, stable value funds, and other investments marketed as low-risk, low-reward safety nets?

Money market funds are stable—except when they’re not. By law, they’re required to make low-risk investments. Typically, that means buying short-term debt such as government bills and commercial paper. So many citizens have plowed so much cash into these accounts—the SEC estimates $2.5 trillion—that the funds’ daily purchases provide essential lubrication to the gears of the economy.

If this combination of shifting ingredients means that a money market fund is like a hot dog, then at least it’s the kind of high-quality, organic wiener you’d find at Whole Foods Market. You may not know precisely what you’re eating, but it comes from reputable sources.

The catch is that money market funds are not insured by the federal government: Investors have no guarantee that $1,000 deposited into an account today will be available for withdrawal tomorrow. The narrow band of behavior available to money market funds means that they can almost always guarantee a stable share price of $1, but occasionally they do “break the buck.” That’s what happened in the fall of 2008, near the height of the financial crisis, when the Reserve Primary Fund fell to 97¢. In a panic, investors withdrew $300 billion from that and other funds.

Schapiro had sought to lessen the likelihood of that happening again by forcing funds to keep enough capital on hand to handle sudden surges of withdrawals, or by imposing a fee on investors who want to empty their entire accounts. But after commissioner Luis Aguilar—the swing vote on the five-member panel—announced that he was opposed to the proposals, Schapiro conceded that she did not have the votes to push the reforms through. A former SEC chief, Arthur Levitt, called the turn of events a “national disgrace” in an interview Thursday with Bloomberg Radio. (Levitt is a board member of Bloomberg LP, which owns Bloomberg Businessweek.)

In a statement, Schapiro appealed to other regulators. “The issue is too important to investors, to our economy, and to taxpayers to put our head in the sand and wish it away,” she said. “Money market funds’ susceptibility to runs needs to be addressed.”

Another kind of low-risk, low-reward investing option has become increasingly popular since the crisis—but by offering more risk, not less. Stable value funds offer higher returns than money market funds in exchange for more uncertainty and a different behind-the-scenes makeup. They’re essentially bonds that come packaged with insurance; if they lose value, the insurance provides a way to recover full value, even in a down market. There are limitations on accessing the funds, though, which constitute their own kind of risk.

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