Money Market Reform

How concerned would you be if your cash reserve account balance fluctuated – hopefully by not much – reflecting short term conditions?  Say you normally held $30,000 in a money market account as cash reserves, and it might range $29,850 to $30,150, or a half percent fluctuation? If that would make you nervous, then you ought to talk to your financial advisor or call the financial institution to see if your money market share values will retain their constant $1 NAV (net asset value), or if they will float with market conditions, on or after October 15, 2016.

What is money market reform? New SEC rules go into play next month for money market funds and many companies have already made adjustments. Institutional prime and tax-exempt funds will end a 30 year plus tradition of fixed $1 share prices. Instead, share prices will fluctuate daily based on the underlying value of securities.  Funds that hold only government securities (including US Treasuries and agencies) can maintain the $1 NAV price. The reform emerged from the subprime debt crisis in 2008. There was a run on prime money markets by investors (and ran to government funds), the Reserve Primary Fund was the first money fund to “break a buck,” and the Treasury Department stepped in to reduce further contagion. The intent is to promote stability and fairness. Critics point to higher borrowing costs.

How is this relevant to you? First, is the peace of mind issue from price stability of cash reserves. If zero fluctuation of your mattress money describes you, then why stray from the $1 NAV funds? On the other hand, hopefully the daily market price fluctuations are minimal – i.e. they’re related to interest rate changes, or a credit or liquidity issue (see discussion below). Second, is the impact of a potential exodus of investors leaving prime money funds – estimates of up to $300 billion –  in favor of government money funds (note: roughly $2.6 trillion in money market industry). Commercial paper is the primary investment in prime funds, and the commercial paper market shrank resulting in increased borrowing costs. Three-month LIBOR (an unsecured lending rate) is near its highest since 2008. Hence, your borrowing costs may rise if you have loans tied to short term indexes.

Caution for investors seeking higher rates – Investors on a fixed income (e.g. retirees) may be in a tough spot due to low interest rates on savings. However, a key reason you hold money markets is for liquidity (emergency reserves and planned expenses)… cash needs to be available when needed. Be careful if you’re tempted to “stretch” for higher cash flow by reaching for higher yields – including longer maturities, lower quality and annuities, to name a few.

Here’s an example… Ultra-short bond funds became popular in the 2000’s and some of them were used (or marketed) as alternatives to money market funds. They paid an attractive yield. However, the risks included longer maturities, and credit/liquidity issues. One of these funds with “YieldPlus” in its name blew up in the subprime credit crisis. This fund had grown to about twelve billion in assets by mid-2007. However, it was primarily invested in mortgage-backed securities and was longer term (about 6% of the portfolio matured within 6 months). The credit crisis hit, and the portfolio suffered massive redemption calls and illiquidity issues. Share value declined about 47% from its July 2007 high to April 2009. Assets fell to about $140 million. Lawsuits came-a-flying. They ended up paying $200 to $350 million in shareholder settlements and fines.

One would think that an investment with the term “Plus” in its name is a good warning to ask more – “Plus what?” If it means higher return, then you should have good reason to believe there’s higher risk – the trade-off of risk and return. Perhaps it’s a good time to talk with your advisors. Good luck.

About Brian Loy

Brian Loy writes insightful and inspiring articles about the ever-changing world of personal finance and the global trends that affect the risk and return on investments and shape the financial- and retirement-planning process.
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