Traditionally very safe, money market funds may no longer be as reliable
JUANA SUMMERS, HOST:
Money market funds are traditionally super safe investments and pay out a higher return than what you might get from a regular bank account. But after recent bank failures and debates over the debt ceiling, this huge part of the financial system could be on shaky ground. Wailin Wong and Adrian Ma from our daily economics podcast, The Indicator From Planet Money, explain.
WAILIN WONG, BYLINE: Kenechukwu Anadu studies financial stability at the Federal Reserve Bank of Boston. We spoke to him last week, and he wanted us to mention that he's not speaking on behalf of the Fed. He says money market funds were created to give investors better returns than they could get on bank accounts.
KENECHUKWU ANADU: Back in the '70s, there was a Federal Reserve regulation that capped the interest rates that banks could pay.
WONG: So in the early '70s, there were two finance guys who were like, what if people could chip in and invest altogether in something that paid out more than what banks are offering?
ANADU: And this included not just individual investors, but also small businesses that were looking for higher yield and cash options.
WONG: These two guys came up with the first money market fund. Fifty-plus years and several trillion dollars later, this industry has grown into a huge piece of financial infrastructure. So here is how money market funds are structured today. They invest in debt like U.S. Treasurys, corporate bonds and municipal bonds.
ADRIAN MA, BYLINE: These bonds are also short-term, meaning they typically come due in a matter of months instead of years, and they generally have low risk of default. They're considered safe and boring, therefore making money market funds safe and boring.
WONG: And the stability of these funds is reflected in how they're priced. So if you want to invest in a money market fund, you do that by buying shares. But unlike a stock price that bounces around, the price for a money market fund is basically $1 per share.
ANADU: So that means that if I invest $1 into a fund, I can expect to receive one share in the fund. And conversely, if I sell my one share, I expect to receive $1.
MA: If that level falls below a dollar, it is a sign that something has gone really wrong. There's a name for this called breaking the buck.
ANADU: In September of 2008, a large fund broke the buck due to its holdings of Lehman Brothers debt. Of course, Lehman Brothers failed.
WONG: So that Lehman Brothers debt basically just became worthless, right?
ANADU: That's correct. Following this event, investors, you know, likely concerned about losses, redeemed large amounts from their funds.
MA: People who were invested in these funds took their money and stampeded towards the exits.
WONG: When money market funds have to cash out a lot of investors all at once, they can have trouble turning their assets into cash quickly enough. They might have to sell their holdings at a deep discount. When that happens, they've gone from a run to a fire sale.
MA: And that is why the Fed specifically mentioned money market funds in a recent report about financial stability. That report said that during periods of financial stress, there's a risk investors will withdraw their money en masse.
WONG: Things have changed since Lehman collapsed and that one big money market fund broke the buck. Regulators put in safeguards. Certain funds were allowed to temporarily suspend withdrawals or charge investors a fee for taking their money out. And so far, money market funds haven't needed to resort to these measures. Wailin Wong.
MA: Adrian Ma, NPR News. Transcript provided by NPR, Copyright NPR.