A money market fund (also called a money market mutual fund) is an open-ended mutual fund
that invests in short-term debt securities such as US Treasury bills and commercial paper.Money
market funds are widely (though not necessarily accurately) regarded as being as safe as bank
deposits yet providing a higher yield. Regulated in the United States under the Investment
Company Act of 1940, money market funds are important providers of liquidity to financial
intermediaries. Explanation:
Money market funds seek to limit exposure to losses due to credit, market, and liquidity
risks. Money market funds in the United States are regulated by the Securities and Exchange
Commission(SEC) under the Investment Company Act of 1940. Rule 2a-7 of the act restricts
the quality, maturity and diversity of investments by money market funds. Under this act, a money
fund mainly buys the highest rated debt, which matures in under 13 months. The portfolio
must maintain a weighted average maturity (WAM) of 60 days or less and not invest more
than 5% in any one issuer, except for government securities and repurchase agreements.
Unlike most other financial instruments, money market funds seek to maintain a stable value
of $1 per share. Funds are able to pay dividends to investors.
Securities in which money markets may invest include commercial paper, repurchase agreements,
short-term bonds and other money funds. Money market securities must be highly liquid and
of the highest quality. History:
In 1971, Bruce R. Bent and Henry B. R. Brown established the first money market fund. It
was named the Reserve Fund and was offered to investors who were interested in preserving
their cash and earning a small rate of return. Several more funds were shortly set up and
the market grew significantly over the next few years. Money market funds are credited
with popularizing mutual funds in general, which until that time, were not widely utilized.
Money market funds in the United States created a solution to the limitations of Regulation
Q, which at the time prohibited demand deposit accounts from paying interest and capped the
rate of interest on other types of bank accounts at 5.25%. Thus, money market funds were created
as a substitute for bank accounts. In the 1990s, bank interest rates in Japan
were near zero for an extended period of time. To search for higher yields from these low
rates in bank deposits, investors used money market funds for short-term deposits instead.
However, several money market funds fell off short of their stable value in 2001 due to
the bankruptcy of Enron, in which several Japanese funds had invested, and investors
fled into government-insured bank accounts. Since then the total value of money markets
have remained low. Money market funds in Europe have always had
much lower levels of investments capital than in the United States or Japan. Regulations
in the EU have always encouraged investors to use banks rather than money market funds
for short-term deposits. Breaking the buck:
Money market funds seek a stable net asset value, or NAV per share (which is generally
$1.00 in the United States); they aim to never lose money. The $1.00 is maintained through
the declaration of dividends to shareholders, typically daily, at an amount equal to the
fund's net income. If a fund's NAV drops below $1.00, it is said that the fund "broke the
buck." For SEC registered money funds, maintaining the $1.00 flat NAV is usually accomplished
under a provision under Rule 2a-7 of the 40 Act that allows a fund to value its investments
at amortized cost rather than market value, provided that certain conditions are maintained.
One such condition involves a side-test calculation of the NAV that uses the market value of the
fund's investments. The fund's published, amortized value may not exceed this market
value by more than 1/2 cent per share, a comparison that is generally made weekly. If the variance
does exceed $0.005 per share, the fund could be considered to have broken the buck, and
regulators may force it into liquidation. Breaking the buck has rarely happened. Up
to the 2008 financial crisis, only three money funds had broken the buck in the 37-year history
of money funds. It is important to note that, while money
market funds are typically managed in a fairly safe manner, there would have been many more
failures over this period if the companies offering the money market funds had not stepped
in when necessary to support their fund (by way of infusing capital to reimburse security
losses) and avoid having the funds break the buck. This was done because the expected cost
to the business from allowing the fund value to drop—in lost customers and reputation—was
greater than the amount needed to bail it out.
The first money market mutual fund to break the buck was First Multifund for Daily Income
(FMDI) in 1978, liquidating and restating NAV at 94 cents per share. An argument has
been made that FMDI was not technically a money market fund as at the time of liquidation
the average maturity of securities in its portfolio exceeded two years. However, prospective
investors were informed that FMDI would invest "solely in Short-Term (30-90 days) MONEY MARKET
obligations." Furthermore, the rule restricting which the maturities which money market funds
are permitted to invest in, Rule 2-a7 of the Investment Company Act of 1940, was not promulgated
until 1983. Prior to the adoption of this rule, a mutual fund had to do little other
than present itself as a money market fund, which FMDI did. Seeking higher yield, FMDI
had purchased increasingly longer maturity securities, and rising interest rates negatively
impacted the value of its portfolio. In order to meet increasing redemptions, the fund was
forced to sell a certificate of deposit at a 3% loss, triggering a restatement of its
NAV and the first instance of a money market fund "breaking the buck".
The Community Bankers US Government Fund broke the buck in 1994, paying investors 96 cents
per share. This was only the second failure in the then 23-year history of money funds
and there were no further failures for 14 years. The fund had invested a large percentage
of its assets into adjustable rate securities. As interest rates increased, these floating
rate securities lost value. This fund was an institutional money fund, not a retail
money fund, thus individuals were not directly affected.
No further failures occurred until September 2008, a month that saw tumultuous events for
money funds. However, as noted above, other failures were only averted by infusions of
capital from the fund sponsors. September 2008:
Money market funds increasingly became important to the wholesale money market leading up to
the crisis. Their purchases of asset-backed securities and large-scale funding of foreign
banks' short-term U.S.-denominated debt put the funds in a pivotal position in the marketplace.
The week of September 15, 2008, to September 19, 2008, was very turbulent for money funds
and a key part of financial markets seizing up.
Events: On Monday, September 15, 2008, Lehman Brothers
Holdings Inc. filed for bankruptcy. On Tuesday, September 16, 2008, Reserve Primary Fund broke
the buck when its shares fell to 97 cents after writing off debt issued by Lehman Brothers.
Continuing investor anxiety as a result of the Lehman Brothers bankruptcy and other pending
financial troubles caused significant redemptions from money funds in general, as investors
redeemed their holdings and funds were forced to liquidate assets or impose limits on redemptions.
Through Wednesday, September 17, 2008, prime institutional funds saw substantial redemptions.
Retail funds saw net inflows of $4 billion, for a net capital outflow from all funds of
$169 billion to $3.4 trillion (5%). In response, on Friday, September 19, 2008,
the U.S. Department of the Treasury announced an optional program to "insure the holdings
of any publicly offered eligible money market mutual fund—both retail and institutional—that
pays a fee to participate in the program". The insurance guaranteed that if a covered
fund had broken the buck, it would have been restored to $1 NAV.The program was similar
to the FDIC, in that it insured deposit-like holdings and sought to prevent runs on the
bank. The guarantee was backed by assets of the Treasury Department's Exchange Stabilization
Fund, up to a maximum of $50 billion. This program only covered assets invested in funds
before September 19, 2008, and those who sold equities, for example, during the subsequent
market crash and parked their assets in money funds, were at risk. The program immediately
stabilized the system and stanched the outflows, but drew criticism from banking organizations,
including the Independent Community Bankers of America and American Bankers Association,
who expected funds to drain out of bank deposits and into newly insured money funds, as these
latter would combine higher yields with insurance. The guarantee program ended on September 18,
2009, with no losses and generated $1.2 billion in revenue from the participation fees.
Analysis: The crisis, which eventually became the catalyst
for the Emergency Economic Stabilization Act of 2008, almost developed into a run on money
funds: the redemptions caused a drop in demand for commercial paper, preventing companies
from rolling over their short-term debt, potentially causing an acute liquidity crisis: if companies
cannot issue new debt to repay maturing debt, and do not have cash on hand to pay it back,
they will default on their obligations, and may have to file for bankruptcy. Thus there
was concern that the run could cause extensive bankruptcies, a debt deflation spiral, and
serious damage to the real economy, as in the Great Depression.
The drop in demand resulted in a "buyers strike", as money funds could not (because of redemptions)
or would not (because of fear of redemptions) buy commercial paper, driving yields up dramatically:
from around 2% the previous week to 8%, and funds put their money in Treasuries, driving
their yields close to 0%. This is a bank run in the sense that there
is a mismatch in maturities, and thus a money fund is a "virtual bank": the assets of money
funds, while short term, nonetheless typically have maturities of several months, while investors
can request redemption at any time, without waiting for obligations to come due. Thus
if there is a sudden demand for redemptions, the assets may be liquidated in a fire sale,
depressing their sale price. An earlier crisis occurred in 2007–2008,
where the demand for asset-backed commercial paper dropped, causing the collapse of some
structured investment vehicles. As a result of the events, the Reserve Fund liquidated,
paying shareholders 99.1 cents per share. Statistics:
The Investment Company Institute reports statistics on money funds weekly as part of its mutual
fund statistics, as part of its industry statistics, including total assets and net flows, both
for institutional and retail funds. It also provides annual reports in the ICI Fact Book.
At the end of 2011, there were 632 money market funds in operation, with total assets of nearly
US$2.7 trillion. Of this $2.7 trillion, retail money market funds had $940 billion in Assets
Under Management (AUM). Institutional funds had $1.75 trillion under management.
Types and size of money funds: In the United States, the fund industry and
its largest trade organization, the Investment Company Institute, generally categorize money
funds into the type of investment strategy: Prime, Treasury or Tax-exempt as well as distribution
channel/investor: Institutional or Retail. Prime money fund:
A fund that invests generally in variable-rate debt and commercial paper of corporations
and securities of the US government and agencies. Can be considered of any money fund that is
not a Treasury or Tax-exempt fund. Government and Treasury money funds:
A Government money fund (as of the SEC's July 24, 2014 rule release) is one that invests
at least 99.5% of its total assets in cash, government securities, and/or repurchase agreements
that are "collateralized fully" (i.e., collateralized by cash or government securities).
A Treasury fund is a type of government money fund that invests in US Treasury Bills, Bonds
and Notes. Tax-exempt money fund:
The fund invests primarily in obligations of state and local jurisdictions ("municipal
securities") generally exempt from U.S. Federal Income Tax (and to some extent state income
taxes). Institutional money fund:
Institutional money funds are high minimum investment, low expense share classes that
are marketed to corporations, governments, or fiduciaries. They are often set up so that
money is swept to them overnight from a company's main operating accounts. Large national chains
often have many accounts with banks all across the country, but electronically pull a majority
of funds on deposit with them to a concentrated money market fund.
Retail money fund: Retail money funds are offered primarily to
individuals. Retail money market funds hold roughly 33% of all money market fund assets.
Fund yields are typically somewhat higher than bank savings accounts, but of course
these are different products with differing risks (e.g., money fund accounts are not insured
and are not deposit accounts). Since Retail funds generally have higher servicing needs
and thus expenses than Institutional funds, their yields are generally lower than Institutional
funds. SEC rule amendments released July 24, 2014,
have 'improved' the definition of a Retail money fund to be one that has policies and
procedures reasonably designed to limit its shareholders to natural persons.
Money fund sizes: Recent total net assets for the U.S. Fund
industry are as follows: total net assets $2.6 trillion: $1.4 trillion in Prime money
funds, $907 billion in Treasury money funds, $257 billion in Tax-exempt. Total Institutional
assets outweigh Retail by roughly 2:1. The largest institutional money fund is the
JPMorgan Prime Money Market Fund, with over US$100 billion in assets. Among the largest
companies offering institutional money funds are BlackRock, Western Asset, Federated Investors,
Bank of America, Dreyfus, AIM and Evergreen (Wachovia).
The largest money market mutual fund is Vanguard Prime Money Market Fund, with assets exceeding
US$120 billion. The largest retail money fund providers include: Fidelity, Vanguard , and
Schwab. Similar investments:
Money market accounts: Banks in the United States offer savings and
money market deposit accounts, but these should not be confused with money mutual funds. These
bank accounts offer higher yields than traditional passbook savings accounts, but often with
higher minimum balance requirements and limited transactions. A money market account may refer
to a money market mutual fund, a bank money market deposit account (MMDA) or a brokerage
sweep free credit balance. Ultrashort bond funds:
Ultrashort bond funds are mutual funds, similar to money market funds, that, as the name implies,
invest in bonds with extremely short maturities. Unlike money market funds, however, there
are no restrictions on the quality of the investments they hold. Instead, ultrashort
bond funds typically invest in riskier securities in order to increase their return. Since these
high-risk securities can experience large swings in price or even default, ultrashort
bond funds, unlike money market funds, do not seek to maintain a stable $1.00 NAV and
may lose money or dip below the $1.00 mark in the short term. Finally, because they invest
in lower quality securities, ultrashort bond funds are more susceptible to adverse market
conditions such as those brought on by the financial crisis of 2007–2010.
Enhanced cash funds: Enhanced cash funds are bond funds similar
to money market funds, in that they aim to provide liquidity and principal preservation,
but which: Invest in a wider variety of assets, and
do not meet the restrictions of SEC Rule 2a-7; Aim for higher returns;
Have less liquidity; Do not aim as strongly for stable NAV.
Enhanced cash funds will typically invest some of their portfolio in the same assets
as money market funds, but others in riskier, higher yielding, less liquid assets such as:
Lower-rated bonds; Longer maturity;
Foreign currency–denominated debt; Asset-backed commercial paper (ABCP);
Mortgage-backed securities (MBSs); Structured investment vehicles (SIVs).
In general, the NAV will stay close to $1, but is expected to fluctuate above and below,
and will break the buck more often. Different managers place different emphases on risk
versus return in enhanced cash – some consider preservation of principal as paramount, and
thus take few risks, while others see these as more bond-like, and an opportunity to increase
yield without necessarily preserving principal. These are typically available only to institutional
investors, not retail investors. The purpose of enhanced cash funds is not
to replace money markets, but to fit in the continuum between cash and bonds – to provide
a higher yielding investment for more permanent cash. That is, within one's asset allocation,
one has a continuum between cash and long-term investments:
Cash – most liquid and least risky, but low yielding;
Money markets / cash equivalents; Enhanced cash;
Long-term bonds and other non-cash long-term investments – least liquid and most risky,
but highest yielding. Enhanced cash funds were developed due to
low spreads in traditional cash equivalents. There are also funds which are billed as "money
market funds", but are not 2a-7 funds (do not meet the requirements of the rule). In
addition to 2a-7 eligible securities, these funds invest in Eurodollars and repos (repurchase
agreements), which are similarly liquid and stable to 2a-7 eligible securities, but are
not allowed under the regulations. Systemic risk and regulatory reform:
A deconstruction of the September 2008 events around money market funds, and the resulting
fear, panic, contagion, classic bank run, emergency need for substantial external propping
up, etc. revealed that the U.S. regulatory system covering the basic extension of credit
has had substantial flaws that in hindsight date back at least two decades.
It has long been understood that regulation around the extension of credit requires substantial
levels of integrity throughout the system. To the extent regulation can help insure that
base levels of integrity persist throughout the chain, from borrower to lender, and it
curtails the overall extension of credit to reasonable levels, episodic financial crisis
may be averted. In the 1970s, money market funds began disintermediating
banks from their classic interposition between savers and borrowers. The funds provided a
more direct link, with less overhead. Large banks are regulated by the Federal Reserve
Board and the Office of the Comptroller of the Currency. Notably, the Fed is itself owned
by the large private banks, and controls the overall supply of money in the United States.
The OCC is housed within the Treasury Department, which in turn manages the issuance and maintenance
of the multi-trillion dollar debt of the U.S. government. The overall debt is of course
connected to ongoing federal government spending vs. actual ongoing tax receipts. Unquestionably,
the private banking industry, bank regulation, the national debt, and ongoing governmental
spending politics are substantially interconnected. Interest rates incurred on the national debt
is subject to rate setting by the Fed, and inflation (all else being equal) allows today's
fixed debt obligation to be paid off in ever cheaper to obtain dollars. The third major
bank regulator, designed to swiftly remove failing banks is the Federal Deposit Insurance
Corporation, a bailout fund and resolution authority that can eliminate banks that are
failing, with minimum disruption to the banking industry itself. They also help ensure depositors
continue to do business with banks after such failures by insuring their deposits.
From the outset, money market funds fell under the jurisdiction of the SEC as they appeared
to be more like investments (most similar to traditional stocks and bonds) vs. deposits
and loans (cash and cash equivalents the domain of the bankers). Although money market funds
are quite close to and are often accounted for as cash equivalents their main regulator,
the SEC, has zero mandate to control the supply of money, limit the overall extension of credit,
mitigate against boom and bust cycles, etc. The SEC's focus remains on adequate disclosure
of risk, and honesty and integrity in financial reporting and trading markets. After adequate
disclosure, the SEC adopts a hands off, let the buyer beware attitude.
To many retail investors, money market funds are confusingly similar to traditional bank
demand deposits. Virtually all large money market funds offer check writing, ACH transfers,
wiring of funds, associated debit and credit cards, detailed monthly statements of all
cash transactions, copies of canceled checks, etc. This makes it appear that cash is actually
in the individual's account. With net asset values reported flat at $1.00, despite the
market value variance of the actual underlying assets, an impression of rock solid stability
is maintained. To help maintain this impression, money market fund managers frequently forgo
being reimbursed legitimate fund expenses, or cut their management fee, on an ad hoc
and informal basis, to maintain that solid appearance of stability.
To illustrate the various blending and blurring of functions between classic banking and investing
activities at money market funds, a simplified example will help. Imagine only retail "depositors"
on one end, and S&P 500 corporations borrowing through the commercial paper market on the
other. The depositors assume: Extremely short durations (60 days or
less) Extremely broad diversification (hundreds,
if not thousands of positions) Very high grade investments.
After 10–20 years of stability the "depositors" here assume safety, and move all cash to money
markets, enjoying the higher interest rates. On the borrowing end, after 10–20 years,
the S&P 500 corporations become extremely accustomed to obtaining funds via these money
markets, which are very stable. Initially, perhaps they only borrowed in these markets
for a highly seasonal cash needs, being a net borrower for only say 90 days per year.
They would borrow here as they experienced their deepest cash needs over an operating
cycle to temporarily finance short-term build ups in inventory and receivables. Or, they
moved to this funding market from a former bank revolving line of credit, that was guaranteed
to be available to them as they needed it, but had to be cleaned up to a zero balance
for at least 60 days out of the year. In these situations the corporations had sufficient
other equity and debt financing for all of their regular capital needs. They were however
dependent on these sources to be available to them, as needed, on an immediate daily
basis. Over time, money market fund "depositors"
felt more and more secure, and not really at risk. Likewise, on the other end, corporations
saw the attractive interest rates and incredibly easy ability to constantly roll over short
term commercial paper. Using rollovers they then funded longer and longer term obligations
via the money markets. This expands credit. It's also over time clearly long-term borrowing
on one end, funded by an on-demand depositor on the other, with some substantial obfuscation
as to what is ultimately going on in between. In the wake of the crisis two solutions have
been proposed. One, repeatedly supported over the long term by the GAO and others is to
consolidate the U.S. financial industry regulators. A step along this line has been the creation
of the Financial Stability Oversight Council to address systemic risk issues that have
in the past, as amply illustrated by the money market fund crisis above, fallen neatly between
the cracks of the standing isolated financial regulators. Proposals to merge the SEC and
CFTC have also been made. A second solution, more focused on money market
funds directly, is to re-regulate them to address the common misunderstandings, and
to insure that money market "depositors", who enjoy greater interest rates, thoroughly
understand the actual risk they are undertaking. These risks include substantial interconnectedness
between and among money market participants, and various other substantial systemic risks
factors. One solution is to report to money market
"depositors" the actual, floating net asset value. This disclosure has come under
strong opposition by Fidelity Investments, The Vanguard Group, BlackRock, the U.S. Chamber
of Commerce as well as others. The SEC would normally be the regulator to
address the risks to investors taken by money market funds, however to date the SEC has
been internally politically gridlocked. The SEC is controlled by five commissioners, no
more than three of which may be the same political party. They are also strongly enmeshed with
the current mutual fund industry, and are largely divorced from traditional banking
industry regulation. As such, the SEC is not concerned over overall credit extension, money
supply, or bringing shadow banking under the regulatory umbrella of effective credit regulation.
As the SEC was gridlocked, the Financial Stability Oversight Council promulgated its own suggested
money market reforms and threatens to move forward if the SEC doesn't button it up
with an acceptable solution of their own on a timely basis. The SEC has argued vociferously
that this is "their area" and FSOC should back off and let them handle it, a viewpoint
shared by four former SEC Chairmen Roderick Hills, David Ruder, Richard Breeden, and Harvey
Pitt, and two former commissioners Roel Campos and Paul S. Atkins.
Reform: SEC Rule Amendments released July 24, 2014:
The Securities and Exchange Commission (SEC) issued final rules that are designed to address
money funds' susceptibility to heavy redemptions in times of stress, improve their ability
to manage and mitigate potential contagion from such redemptions, and increase the transparency
of their risks, while preserving, as much as possible, their benefits.
There are several key components: Floating NAV required of institutional non-government
money funds: The SEC is removing the valuation exemption
that permitted these funds (whose investors historically have made the heaviest redemptions
in times of stress) to maintain a stable NAV, i.e., they will have to transact sales and
redemptions as a market value-based or "floating" NAV, rounded to the fourth decimal place (e.g.,
$1.0000). Fees and gates:
The SEC is giving money fund boards of directors the discretion whether to impose a liquidity
fee if a fund's weekly liquidity level falls below the required regulatory threshold, and/or
to suspend redemptions temporarily, i.e., to "gate" funds, under the same circumstances.
These amendments will require all non-government money funds to impose a liquidity fee if the
fund's weekly liquidity level falls below a designated threshold, unless the fund's
board determines that imposing such a fee is not in the best interests of the fund.
Other provisions: In addition, the SEC is adopting amendments
designed to make money market funds more resilient by increasing the diversification of their
portfolios, enhancing their stress testing, and improving transparency by requiring money
market funds to report additional information to the SEC and to investors. Additionally,
stress testing will be required and a key focus will be placed on the funds ability
to maintain weekly liquid assets of at least 10%. Finally, the amendments require investment
advisers to certain large unregistered liquidity funds, which can have many of the same economic
features as money market funds, to provide additional information about those funds to
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