Until recently, money market funds have been a boring place to hold cash and it worked very similarly to a bank account — you had a stable value, share prices were always $1, and you earned a yield on your “deposit.” This will change for many funds this October 14th as a new amendment to the SEC’s regulations governing money market mutual fund goes into effect.
Prior to the 2008 financial crisis, money market sponsors stepped in and purchased any bad paper in the fund to preserve the $1 Net Asset Value (NAV). Unfortunately, Reserve Primary, the oldest and largest money market fund, did not have the resources to buy back the Lehman paper in its fund. On September 16th, it announced that it could no longer hold the stable value. This event created a run on money market funds, which forced the government to provide deposit insurance like the FDIC provides for bank deposits. The government decided that it could not let this happen again so it enacted these new rules.
Starting after October 14th, all institutional prime and municipal bond money markets will have a floating NAV. A prime fund is a money market that invests in a variety of short term debt including commercial paper, bankers’ acceptances, and Eurodollar deposits. Now only funds investing in government securities and agency issues from Freddie Mac or Fannie Mae will have stable values. In addition, fund companies can impose exit fees of up to 2% for a limited time on all prime and municipal funds. They can also suspend withdrawals for up to 10 business days.
The rules create a new distinction between retail and institutional money market funds and impose greater rules on institutional funds. Because many investors desire a stable NAV, a number of fund companies are changing the structure of their prime funds and will no longer invest in commercial paper. As a matter of fact, $1 trillion has already been moved from prime funds to government funds. Due to the fact that interest rates are so low, the change in yield from a prime fund to a government fund will be small — probably in the 0.10% range. However, the greater demand for government paper and the reduced demand for commercial paper could lead to a widening of yields if interest rates increase.
For now, most investors will realize little difference. Hopefully, the new rules will add stability to money markets so there is no repeat of the past.
Washington Trust Bank believes that the information used in this study was obtained from reliable sources, but we do not guarantee its accuracy. Neither the information nor any opinion expressed constitutes a solicitation for business or a recommendation of the purchase or sale of securities or commodities.
Washington Trust Bank.