Article from The New York Times
Money market mutual funds offer higher-interest rates than most bank deposits do, with much of the convenience and liquidity of bank accounts. The funds are invested in short-term certificates of deposit, Treasury securities and government or corporate bonds. Since those classes of investment are generally safe, since they first became popular in the early 1980s money market funds have come to be regarded as being as safe as bank deposits. But they are not covered by the F.D.I.C.'s deposit guarantee, and however "safe" the securities they invest in, they contain an element of risk. Indeed, the very reason they yield more than savings accounts is that they are riskier.
In September 2008, with the financial world teetering on the edge, investors were given a rude reminder of those facts when a prominent money market fund announced that its value had fallen below the amount investors had deposited -- it had "broken the buck,'' in Wall Street's parlance. Quick government action reassured the market, but a year later questions remained about potential changes in regulation that could have the effect of making risks clearer to investors.
The key to the long-held perception that money market funds are akin to savings accounts is the stable $1 "net asset value," or N.A.V. But it wasn't always that way. When money market funds were first created in the early 1970s, they had a "floating" N.A.V., just like any other kind of mutual fund.
On the day a fund opened, it would be set at $10 a share. Investors would get the numbers of shares that equaled their investment. The fund manager tried to maintain that price, but it would often fluctuate between, say, $9.97 and $10.03. Most days, though, it stayed at $10, and even when it didn't, the world didn't come to an end.
By the time money funds became truly popular, however, they did have that fixed $1 share price. This was during the early 1980s, when interest rates had skyrocketed and money funds - unlike regulated savings accounts - offered market rates of interest. In the late 1970s, the industry had persuaded the S.E.C. to allow it to move to a stable N.A.V., which it pushed for precisely because it wanted money funds to resemble a bank account, with which they were competing. To accomplish this, a series of new regulations were required, one of which exempted money funds from mark-to-market accounting, while others imposed limits on the kinds of short-term securities they could hold.
People flocked to money market funds in the early 1980s because they were the only tool available to prevent middle-class savings from being eroded by inflation. Then, when the bull market began in 1982, Americans gradually moved that money into mutual funds.
But money market funds didn't fade away, even after bank savings accounts were deregulated. They offered higher yields than people could get at the bank, and even though they lacked government insurance, people used them the same way they used a bank account: as a place to park cash. The industry became so committed to the idea that money funds should serve as alternatives to bank accounts that on the rare occasions when a money fund threatened to break the buck - that is, lose a penny or two - the company that owned the fund invariably put up the cash to prevent any losses.
In September, 2008, when the financial world seemed on the brink of collapse, the Treasury Department put in place a program that essentially gave the same kind of protection to money market investors that the Federal Deposit Insurance Corporation gives to bank depositors.
The Reserve Primary Fund, a $62.5 billion money market fund, had "broken the buck." With $785 million in defaulted Lehman Brothers bonds in its portfolio, it had been unable to maintain the $1 share price that has long been a priority for money market funds, falling to 97 cents. Investors scrambled for the exits, and though the Reserve Fund didn't really "collapse," the government rushed to the rescue, guaranteeing that investors wouldn't lose a penny.
As the Treasury Department ends the program, in September 2009, one way to try to solve this problem is to make money funds "safer" than ever, largely through regulation. That is the route the S.E.C. is taking, and that the industry is encouraging. That route will continue to allow investors to believe that money funds are, essentially, higher-yielding bank accounts.
There is another option: a return to the floating N.A.V. There would still be rules about what kinds of securities a money market fund could hold, but it would also be a market-driven acknowledgment that money market funds were riskier than bank accounts. The proof would be the fact that the N.A.V. would occasionally fluctuate.
Article from The New York Times