Markets have been shaky since the Federal Reserve began raising interest rates last year to fight inflation.
Stocks and bonds have lost money. The cost of financing a car, a house, or even a small credit card purchase has increased. Two major regional US banks failed and required bailouts, and concerns about a potential recession have spread.
But it’s been a glorious time for one part of the financial world: money market funds. The largest money funds tracked by Crane Data pay more than 4.6 percent interest, and a handful have returns around 5 percent.
Their gaudy interest rates closely track the Fed Funds rate, set by the central bank. The effective Fed Funds rate is now about 4.83 percent. That’s inconvenient for people who need to borrow money, and that’s on purpose: the Fed is raising interest rates as it tries to quell inflation by slowing the economy.
What’s painful for borrowers is great for people who need a place to park money they’ve set aside to pay the bills. In an effort to retain customers, some banks have begun raising interest rates on savings accounts and certificates of deposit, even though most bank deposits remain in accounts that pay out next to nothing.
That has given money market funds a magnetic appeal. Their assets have swelled to more than $5.6 trillion, from $5.2 trillion in December 2021 when the Fed started talking about impending rate hikes. Money market funds will likely continue to grow if the Fed keeps rates at current levels or raises them further.
I have used money market funds for decades with no problems and I consider them to be fairly, if not entirely, safe. I think it’s reasonable to put some of your money into it as long as you’re careful and keep your eyes wide open.
The landscape changes
In June, as money market rates rose from the near-zero point at which they had languished to a whopping 0.7 percent, I pointed out that for the first time in ages it made sense to start looking around for places to park your money.
Gone are the days when you were sentenced to receive nothing for the privilege of holding your money in a financial institution, if you were willing to do anything. When interest rates began to rise, money market rates immediately began to rise, creating a large gap with bank deposit rates.
That gap has now widened to its largest level in decades. The benefits of money market funds are becoming increasingly apparent, not only to corporate finance officers who have always used them as an efficient and high-yielding place to hold money, but also to thousands of ordinary people, who are finally getting something for their money.
Say you need to stash $10,000 somewhere. Keep it in a checking account and you will receive nothing or almost nothing. Keep it in a money market fund and pay 5 percent for a year and you will receive $500.
That won’t make you rich. Depending on consumer prices, you may lose inflation-adjusted purchasing power. Currently, money market yields are just beginning to approach the annual percentage of the consumer price index, which was 5 percent in March. But compared to nothing, $500 is great.
Some banks are beginning to offer competitive rates with Federal Deposit Insurance Corporation insurance. For example, Apple has teamed up with Goldman Sachs and is marketing a 4.15 percent interest rate bill. Many other financial institutions also compete for attention, but generally lag behind money market rates.
In short, if you’re a money market fund investor, rising interest rates can be delightful. But in the world of finance, an advantage is rarely without a cost.
Known vulnerabilities
Investors have never experienced major losses in money market funds in the United States, and I find that a reassuring record.
But that doesn’t mean the funds are risk-free.
On the one hand, there are already indications that their growing popularity is partly at the expense of banks, especially smaller ones that have lost deposits. Such losses — which contributed to the collapse of Silicon Valley Bank and Signature Bank last month — have created stress throughout the financial system.
More than $560 billion in deposits left the commercial banking system through April 5 this year, according to government figures. At the same time, according to Crane Data, more than $442 billion flowed into money market funds. That’s been great for fund investors’ income, but it’s a mixed bag for financial institutions.
This is reflected in individual companies. For example, at Charles Schwab, which just released its quarterly results, the company’s banking division lost $41 billion in deposits in the first three months of the year. At the same time, Schwab’s money market funds gained $80 billion.
For Schwab customers, the shift has been a huge boon. For them it means a significant increase in income. For the company’s shareholders, however, it means a contraction in profits. As a company, Schwab says, it is strong enough to handle the shift. That may be so, but not all financial institutions are in good shape right now.
Financial regulators are closely monitoring these issues.
Money market ‘walking’
It’s not just banks that are vulnerable to “runs” – panics, where people rush to withdraw their money and push others to do the same, in a vicious circle. Money market funds are also periodically subject to runs.
There are only two known incidents where money market funds were unable to pay 100 cents for every dollar invested in them – they “broke the buck”, in Wall Street parlance – and despite headaches and long payment arrears, no significant losses in those cases.
But there have been many near misses. A 2012 report from the Federal Reserve Bank of Boston found more than 200 cases where money market fund companies quietly poured money into them to ensure the funds could pay investors 100 percent of the money they expected.
Recall that the Fed had to restore calm during money market runs in 2008 and again in 2020, during a brief crisis at the start of the coronavirus pandemic. The Securities and Exchange Commission, which regulates money market funds, has already tightened its rules twice and is proposing additional changes.
Federal involvement in the money markets has become a constant. Since the 2020 crisis, money market funds have increasingly relied on a Fed backstop – the reverse repo transactions or “reverse repos” of the Federal Reserve Bank of New York. Most of the investments of many money market funds are government bonds that are sold overnight by the Fed. In total, there is more than $2.2 trillion in securities in this market.
On March 30, in the midst of the latest banking crisis, Treasury Secretary Janet L. Yellen focused on money market funds as a point of special concern. “If there’s one place where the system’s vulnerabilities to runs and sell-offs are obvious, it’s money market funds,” she said. “These funds are widely used by retail and institutional investors for cash management; they provide a good substitute for bank deposits.
While Ms Yellen noted that regulations had already been tightened, she said much more needed to be done. “The financial stability risks of the money market and open-ended funds have not been adequately addressed,” she said.
How to use them
Recently, I have several places to stash the money I need to pay the bills.
These include accounts with a major international merchant bank, a credit union, an online high-yield FDIC-insured savings bank, and a low-fee money market fund with a large, reputable asset management company. I’ve held some money in all of these funds for the past two years, although the money market fund has become my favorite of late as it consistently generates cash.
But if the Fed pushes interest rates back down – which could happen soon if a recession comes, or in many months if inflation persists – money market fund yields will also fall and I will reduce my holdings in them.
I am also aware of the potential dangers associated with money market funds. To minimize risk, I use a so-called government fund – a fund that only holds government bonds, other securities of the US government and US institutions, and reverse repo securities with the Fed. That eliminates the possibility that my fund will hold securities issued by a private company that goes bankrupt – as Lehman Brothers did in 2008, which caused problems for some money market funds.
Of course, Treasury bills aren’t 100 percent safe either, not with the federal debt ceiling looming. As mind-boggling as this may be, the US government may not be able to meet its debts. Many money market funds avoid Treasury bills that could become due during a debt ceiling stalemate.
In the end, I expect that reason will prevail and that the US government will pay all its bills. Should it nevertheless default on the Treasury’s obligations, no other financial security in the United States would be completely safe.
But for the money I really need, I’ll be sure to have a larger portion of my money in FDIC-insured accounts when the climax of the debt ceiling battle appears to have arrived, possibly as early as June.
Therefore, the general rules of investing apply even when it comes to safe places to keep your money: spread your holdings and try to understand how much risk you are taking with your money.
I am concerned about money market funds. They are not 100 percent safe. But I’m thankful to have them.
