The State of the Money Market

In this current market morass, a lot of investors are looking to move to cash. Unfortunately, cash isn’t as safe as it once was, either. In some countries, the unwinding of the financial markets has dragged down the value of the currency (think Iceland); in the United States, there’s been uncertainty about what investments are just as safe as cash.

From 2003 to 2007, just 10 banks failed in the United States. A few weeks ago, I went to bed as a Washington Mutual customer and woke up in the J.P. Morgan Chase empire. Washington Mutual was one of 13 banks that have failed thus far this year, and it’s likely to have more company as the year progresses. Thanks to the FDIC, though, my checks are clearing, my cash station card works and my CDs are still earning interest.

The FDIC has proved to be an effective backstop for banks, but most investors have plenty of cash outside of banks. Money market mutual funds often offer higher returns than banks, and they are managed to have almost no risk of loss. But in a market like this, a whole bunch of people are finding out the importance of the word "almost." The last time that a money market mutual fund had a similar problem, it was isolated to bad investments at one company, Strong Funds (now Wells Fargo), in the mid-1990s. Strong made up the loss from its own coffers.

That hasn’t been possible this time. Many colleges are now facing a short-term financial crunch because Commonfund, a non-profit money manager that works with many endowments, has had problems with its Fund for Short Term Investments. That’s a  money market mutual fund for campuses, and the market value of many of its holdings fell enough that it had posted losses. Because almost all of the assets will return to their full face value at maturity, the fund’s managers decided to limit withdrawals. But if a school needs the money to meet payroll or cover the light bills, it’s stuck for now with access to only 40% of its holdings at press time.

To prevent a run on other money funds that could make a bad market even worse, the Treasury included temporary insurance for money market mutual funds in the mega-bailout program. Participating mutual fund companies pay between 0.01% and 0.015% of assets to the Treasury, a cost that will probably be pushed to fund shareholders as part of the overall expense ratio. Most of the large fund companies agreed to participate, including Fidelity, Vanguard and T. Rowe Price.

To find out if your fund participates, you’ll need to call the fund company, although it may have already sent out a glossy flyer trumpeting its new insurance. Small funds might not be insured; you can take the very small risk of losing money, or you can move your funds elsewhere. Remember that for the first time in a long time, banks may offer higher rates than mutual fund companies. Troubled banks tend to pay higher rates of interest in order to attract funds to shore up their balance sheets, so there’s a reason I had some CDs at Washington Mutual.

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