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It's 2012: Do You Know Where Your Money Market Fund Is?

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Would you take money that you needed for next month's mortgage payment and deposit it at a European bank? Would you take money that your daughter needs for braces this summer and make a short term loan to a Wall Street firm? Probably not, but if you've put your ready cash in a prime money market fund, those are exactly the kinds of places where your money may be sitting right now.

To be sure, most mutual fund companies try to invest their money market accounts prudently. When you put your cash into a money market fund, it is expected that your dollars won't lose value. Unlike other mutual funds, where the value of the shares will float in accordance with how well the fund's investments are performing, a money fund tries to act like an FDIC-insured bank account, and never be worth less than the amount you have put into it.

But prior to 2008 financial crisis, a number of money funds took high risk bets on commercial paper issued by risky firms like Lehman Bros, or they lent to the infamous "SIVs," those "short term investment vehicles," which loaded up on toxic mortgage-backed securities. This risk-taking came home to roost when the Reserve Fund, the nation's oldest money fund, "broke the buck" on its Lehman investments. Money fund customers, who previously assumed that their accounts had bank-like safety, ran in droves when they realized that was not the case. In one short week, $350 billion -- 15 percent of all prime money fund investments -- were withdrawn, threatening to destabilize the financial system. The U.S. taxpayer had to step in with a temporary guarantee program to prevent further runs.

Under Dodd-Frank, the financial reform law enacted in 2010, taxpayer bailouts of the financial industry are now prohibited. The SEC wants to make sure that money fund investors understand this. One reform the SEC is considering would require shares in money funds to float in value as do other types of mutual funds. This would reinforce for money fund customers that their money is not guaranteed as it is with an FDIC-insured bank account. Another, more complicated, option would require money fund sponsors to set aside additional capital to absorb losses on money fund investments, as well as hold back 3-5 percent of an account holder's money for 30 days to discourage runs.

Mutual fund lobbyists are trying to scare people by saying that these proposals will lead to onerous tax consequences, that they will lower returns, and potentially kill off the industry. But the tax consequences will be no more onerous than they are for any other mutual fund. And if being honest with people about the true risks of these accounts will kill the industry (which I doubt), then so be it.

Industry lobbyists also argue that the SEC is over-reacting, since a money fund has only "broken the buck" a few times in the industry's 40-year history. In fact, money funds have lost value repeatedly in the past, but customers did not see it because the funds' parent companies stepped in with their own cash to make up for the losses. Moreover, the Reserve Fund incident underscores the cataclysmic consequence of a run when a major fund does "break the buck." We cannot afford the risk of that happening again -- not even once.

Money fund customers and taxpayers alike should applaud what the SEC is trying to accomplish. The SEC wants to make sure that money fund customers' expectations are realistic and informed, and it wants to make sure the money fund industry can meet those expectations, without resorting to government bailouts. Money market funds are still at risk for another run. And if that happens, their customers' losses will far surpass any short-term costs associated with the industry's exaggerated claims of lower returns or tax inconvenience.