The risks of money market funds
Money market funds (MMFs) are often the only option companies have heard of for achieving better yields on their cash reserves. But despite industry marketing that attempts to position them as safe substitutes to bank deposits, their real-world track record is more mixed.
MMFs are often marketed as having the benefits of cash: easy liquidity (you can get your money out any time) and value stability (a dollar invested will always be worth at least a dollar). But it’s important to understand that even the most conservative MMFs are mutual funds (pooled investment vehicles) that hold a wide variety of non-cash instruments, like government debt and corporate bonds. If you invest and later want your cash back, the fund sponsor (the firm managing the fund) must sell some of their holdings to honor that request.
In good times, MMF sponsors are able to cover withdrawal requests with little issue, hence their “cash-like” quality. But in bad times, like the 2008 financial crisis or the 2020 market crash, these investment vehicles are subject to both liquidity risk and price risk. In fact, since their creation in 1971, sponsors of MMFs have “bailed out”—or injected capital into the instrument to preserve a net asset value (NAV) of one dollar—hundreds of times.1 Sometimes, these efforts fail.
2008: the Lehman Brothers collapse
The most infamous example occurred in September 2008. In the wake of the Lehman Brothers bankruptcy, a renowned MMF called Reserve Primary Fund of New York “broke the buck,” which means its NAV per share declined below one dollar. This prompted investors, fearing further declines, to attempt to withdraw their holdings. To meet those redemptions, the fund’s sponsors were forced to liquidate assets on unfavorable terms, which accelerated the mass exit of investors. Within 24 hours, shareholders had withdrawn $40bn of the original $62bn of assets under management (AUM), and the Reserve's sponsors were compelled to freeze withdrawals. Two weeks later, the Reserve Fund—the first MMF to exist—was liquidated.
Other MMFs suffered collateral damage as investors panicked and withdrew hundreds of billions in shares. Only when the Fed publicly guaranteed a NAV per share of one dollar for all MMFs did the sector regain stability.
Prime MMF Holdings June–December 2008
In August through September 2008, investors withdrew over $400bn—over 30% of AUM—from prime MMFs in response to concerns about stability. Source: Western Asset2
2020: the COVID-19 pandemic
In a faster-moving repeat of 2008, investors withdrew cash from MMFs in large quantities when the underlying assets became subject to pandemic-driven volatility. Though some investors expected the post-2008 reforms to protect the market, “those reforms were known to be insufficient,” according to Ben S. Bernanke, former Federal Reserve Chairman.3
In response, increasingly more investors raced to withdraw cash as the NAV per share for some prime MMFs dropped below one dollar.4 Investor’s behavior was unpredictable, concluded the Bank for International Settlements: “The experience of individual funds was highly uneven. During the run, cumulative redemptions ranged from 5 to 40% of pre-run AUM for half of the funds, with a quarter of the funds faring much worse.”5
MMF Holdings December 2019–June 2020
During March 2020, investors withdrew $100bn—over 30% of AUM—from prime MMFs, once more in response to concerns about stability. Source: Western Asset6
Renewed volatility
The pattern seems clear: MMFs are generally safe—until significant market instability emerges. And while a public bailout of investor's holdings can occur, it is nor guaranteed in any of the major economies, including the US: “MMFs, like other investment funds, are not eligible for the protections provided to modern bank deposits, including public backstops such as deposit guarantee schemes.”7 As a result, since 2000, MMF runs have occurred in many countries and under various regulatory regimes of varying strictness.
“The stable $1.00 share price has fostered an expectation of safety, although money market funds are subject to credit, interest-rate and liquidity risk. Recurrent sponsor support has taught investors to look beyond disclosures that these investments are not guaranteed and can lose value." —Former SEC Chairman Mary L. Schapiro
Much of MMFs’ reputation as a cash-like instrument is propped up by their sponsor's ability to support them with outside capital when required. As then–SEC Chairman Mary L. Schapiro said in June 2012, “The stable $1.00 share price has fostered an expectation of safety, although money market funds are subject to credit, interest-rate and liquidity risk. Recurrent sponsor support has taught investors to look beyond disclosures that these investments are not guaranteed and can lose value.”8
During a true crisis, sponsor support is rarely enough—and federal support for every investor is not guaranteed.While market events like the collapse of the Reserve Primary Fund or the COVID-19 pandemic cannot be foreseen, we are witnessing resurgent volatility today. Early warning signs include a rise in inflation, low unemployment rates and usually-reliable tech stocks rapidly losing value.
Consumer Price Index (CPI) for all urban consumers 2000-2022
The last year has seen a massive increase in CPI for all urban consumers, echoing a similar but smaller increase in early 2008. Source: St. Louis Federal Reserve Bank
Unemployment rate 2000-2022
The US is experiencing unemployment rates similar to those precipitating both the 2008 and 2020 crises. Source: St. Louis Federal Reserve Bank
NASDAQ-100 (NDX) 2000-2022
Declines in usually-reliable technology stocks have half-erased the tech-heavy NASDAQ’s two year–long rally, echoing the dot-com bust of 2001. Source: Yahoo! Finance
Looking ahead
We believe companies shouldn’t take risks with their capital—they should be optimizing for the highest yield while alsomaximizing safety and liquidity. As a result, Mayfair purposely does not invest in or offer MMFs for the reasons seen above.
Instead, we only hold your cash at FDIC-insured banks where it can earn maximum yield without sacrificing safety or immediate availability. That's especially important in a market driven by post-COVID complexity, supply chain problems, high inflation as well as widespread public and private market repricing.
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1. Mary L. Schapiro, “Testimony on ‘Perspectives on Money Market Mutual Fund Reforms,’” U.S. Securities and Exchange Commission (U.S. Securities and Exchange Commission, June 21, 2012), https://www.sec.gov/news/testimony/2012-ts062112mlshtm.
2. Matt Jones, “Changes Are Coming to Money Market Funds (Again),” Western Asset (Western Asset, August 4, 2022), https://www.westernasset.com/us/en/research/blog/changes-are-coming-to-money-market-funds-again-2022-08-04.cfm.
3. Smialek, J. (2021) Money market funds melted in pandemic panic. now they're under scrutiny., The New York Times. The New York Times. Available at: https://www.nytimes.com/2021/04/23/business/economy/money-market-funds-reform.html(Accessed: October 21, 2022).
4. Vanessa A. Countryman, “Money Market Fund Reforms,” Federal Register (Securities and Exchange Commission, February 8, 2022), https://www.federalregister.gov/documents/2022/02/08/2021-27532/money-market-fund-reforms.
5. Avalos, Fernando and Dora Xia, “Investor Size, Liquidity and Prime Money Market Fund Stress,” The Bank for International Settlements (The Bank for International Settlements, March 1, 2021), https://www.bis.org/publ/qtrpdf/r_qt2103b.htm.
6. Matt Jones, “Changes Are Coming to Money Market Funds (Again),” Western Asset (Western Asset, August 4, 2022), https://www.westernasset.com/us/en/research/blog/changes-are-coming-to-money-market-funds-again-2022-08-04.cfm.
7. Bouveret, Antoine, Antoine Martin, and Patrick E. McCabe (2022). “Money Market Fund Vulnerabilities: A Global Perspective,” Finance and Economics Discussion Series 2022-012. Washington: Board of Governors of the Federal Reserve System, https://doi.org/10.17016/FEDS.2022.012.
8. Mary L. Schapiro, “Testimony on ‘Perspectives on Money Market Mutual Fund Reforms,’” U.S. Securities and Exchange Commission (U.S. Securities and Exchange Commission, June 21, 2012), https://www.sec.gov/news/testimony/2012-ts062112mlshtm.
