Changes to Money Market Funds have been coming since 2008

Investors in general are receiving mail about a (normally) pretty dry topic: Money Market funds.
Really? Money Market funds? Is all this mail really necessary?

Most individuals don’t give “money market accounts” any thought.
It’s just a parking place for cash, right?

The biggest change swirls around the creation of “Institutional” Money Market funds (or “Prime” funds) and separate Money Market funds for individuals. Money market funds for individuals are designed (going forward) to not go below $1 per share. Prime Money Market Funds (for Institutions) will have the potential to “float” (go below $1/share).

What? Go down in value? It’s a money market fund!

Every money market fund…. is technically called a “money market mutual fund.” Yes, it is a mutual fund! And, as with all mutual funds, the broker (Schwab, TD Ameritrade, etc) is required to send you a prospectus by mail. That’s why you are getting mail about money market funds.

In a nutshell, money market mutual funds hold really short term investments (usually coming due 90 days or less). Each day, the prices of these investments change, the assets get added up, and at the end of the day, they should add up to $1.00 per share.

In the past, it “usually” worked that way. Every so often the price would come in between $0.99 and $1.00 per share. But the value would not change on your statement.

While one short-term fund “broke the buck” back in the late 1970’s (when these investments were brand new), the next time a money market mutual fund “broke the buck” was in 1994. When Orange County, CA filed bankruptcy, one money market fund “broke the buck” meaning the value of the fund closed at less than $1.00 per share.

Seeing a money market fund “break the buck” did not happen again until 2008. When Lehman Brothers collapsed, it threw a wrench into money market operations in a few ways. First, an enormous amount of short term investments issued and backed by Lehman could be found in some money market funds. Next, while other investment firms like Lehman, did the same (issuing plenty of short term investments found in money markets), Lehman ultimately did not survive, and many of their debt-instruments saw severe drops in value. Additionally, as people began taking money out of money market funds (in September 2008), demand for commercial paper began to dry up. Commercial paper are short-term investments many large corporations use to finance daily business. Also, Lehman itself was one of the largest players in trading short term investments (like commercial paper). When Lehman shut down, a large portion of the liquidity in this short term market vanished.

In light of this market seizing up in 2008, the SEC began rolling out significant changes to money market funds. To shore up confidence, the first thing that happened was money market funds became insured temporarily (through October 2009).

One other point about money market funds which often goes overlooked: if you examine your statements, you’ll see you do not have “dollars” in your money market, you hold “shares.” And the shares are all priced on your statement at $1.00. That’s not a mistake. The money market fund is a mutual fund, and has been that way since they were invented back in the late 1970’s.

Technically (before the last few years), it was possible to have lost money in a money market. And very few people even KNEW it.
The managers of money market mutual funds do not work for free, there are costs associated with running a money market fund. In recent years (as interest rates have slid lower and lower), many funds have slashed their fees. Other money market funds opted recently to (temporarily) not take a fee, as the fee would likely be equal to (or higher than) the yield on the fund.

With other areas around the globe now facing negative interest rates, it’s interesting to speculate what might happen to money market funds if we see negative rates here in the United States. What kind of demand would there be for money market rates if they reflected a zero return, or a negative number?