New Rules for Money Market Funds By: Gabriel PotterMBA, AIFA® 2014.08.04

Money market funds are, to most investors, synonymous with cash.  It’s not that simple.  It took the dire times of the financial crisis to prove that money market funds are, although very cautious investments, still investments which can lose value. 

Here’s a quick summary of the financial crisis and why people were so spooked in late 2008.  In September 2008, a key money market fund owned short term commercial paper, basically a short term corporate IOU, with Lehman Brothers, which had just gone bankrupt.  As a result, the money market fund “broke the buck” and was worth less than 100 cents on the dollar.  Investors usually think of money market funds as safe as paper cash, so to lose money on them sent a shockwave through the industry.  The losses were still only a few cents on the dollar, but the damage was enough to prompt a number of money market funds into withdrawing their investments from commercial paper and reinvest into short term treasuries instead.  The outflows from the commercial paper market were enough to cause the market to freeze.  What does that mean?  A company can be perfectly healthy but still be, periodically, cash poor.  In other words, the business is solvent but not liquid.  Without a free flowing commercial paper market, corporations can’t borrow the short term cash they need to pay employees, buy equipment, pay their bills, and so on.  After years of inexpensive, easy borrowing, a full switch to “cash-up-front” was a huge shock that some corporations were simply unprepared for.  To keep short term credit from freezing completely, the government had to create some explicit protections for money market funds – just like they do for cash in banks (via the FDIC).

Fast forward to 2014.  The SEC still wants to maintain the protections for money market investors, but they want to ensure that investors don’t immediately withdraw their funds from the commercial paper market during times of stress.  So, the big change in the new law is to prevent mass withdrawals with fees and liquidity “gates”.  If investors start pulling out their money all at once, the money market fund can simply stop allowing withdrawals temporarily; this is called a gate.  Similarly, during times of stress, a money market fund can impose a redemption fee, up to 2%, to discourage withdrawals.

The full text of the new law can be read here www.sec.gov/rules/final/2014/33-9616.pdf

Gabriel Potter

Gabriel is a Senior Investment Research Associate at Westminster Consulting, where he is responsible for designing strategic asset allocations and conducts proprietary market research.

An avid writer, Gabriel manages the firm’s blog and has been published in the Journal of Compensation and Benefits,...

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