Add stability and liquidity with money market funds

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Investors can purchase shares of money market funds through mutual fundsbrokerage firms and banks. A money market fund's purpose is to provide investors with a safe place to invest easily accessible, cash-equivalent assets.

It is a type of mutual fund characterized as a low-risk, low-return investment. Since money market funds have relatively low returns, investors such as those participating in employer-sponsored retirement plans, might not want to use money market funds as a long-term investment option because they will not see the capital appreciation they require to meet their financial goals.

Aside from being low risk and highly liquid, money market funds may be attractive to investors because they have no loads, which are fees mutual funds may charge for entering or exiting the money market fund liquidity.

A money market fund might also hold short-term U. Treasury securities, such as T-bills; certificates of deposit CDs ; and corporate commercial paper. A downside of money market funds is they are not covered by federal deposit insurance. If invested in a credit union, however, money market accounts are insured through the National Credit Union Agency. Other investments with comparable returns, such as money market deposit accounts, online money market fund liquidity accounts and certificates of deposit, are covered.

However, money market funds are considered safe investments and are regulated under the Investment Company Act of As ofthe most recent occurrence was during the financial crisis ofmoney market fund liquidity caused a run on money money market fund liquidity fund assets. To avoid money market fund liquidity future occurrence, the U.

Securities and Exchange Commission SECissued new rules for the management money market fund liquidity money market funds for the purpose of providing them with more stability and resilience.

The new rules place tighter restrictions on portfolio holdings and introduce triggers for imposing liquidity fees and suspending redemptions. For some investors, this introduces the risk of principal where it never existed before. The floating NAV rule is not likely to affect individual investors who invest in funds designated as retail money market fund liquidity market funds.

Those using a money market fund can typically withdraw their money at any time but may have a limit on the number of times they can withdraw. Money market accounts also differ from typical savings and checking accounts in that they often have higher balance requirements. Pros and Cons of Money Market Funds Aside from being low risk and highly liquid, money market funds may be attractive to investors because they have no loads, which are fees mutual funds may charge for entering or exiting the fund.

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A money market fund also called a money market mutual fund is an open-ended mutual fund that invests in short-term debt securities such as US Treasury bills and commercial paper.

Regulated in the United States under the Investment Company Act of , money market funds are important providers of liquidity to financial intermediaries. Money market funds seek to limit exposure to losses due to credit , market , and liquidity risks. Rule 2a-7 of the act restricts the quality, maturity and diversity of investments by money market funds.

Under this act, a money fund mainly buys the highest rated debt , which matures in under 13 months. Funds are able to pay dividends to investors. Securities in which money markets may invest include commercial paper , repurchase agreements , short-term bonds and other money funds.

Money market securities must be highly liquid and of the highest quality. In , Bruce R. Bent and Henry B. Brown established the first money market fund. Several more funds were shortly set up and the market grew significantly over the next few years. Money market funds are credited with popularizing mutual funds in general, which until that time, were not widely utilized.

Money market funds in the United States created a solution to the limitations of Regulation Q , [6] which at the time prohibited demand deposit accounts from paying interest and capped the rate of interest on other types of bank accounts at 5.

Thus, money market funds were created as a substitute for bank accounts. In the s, bank interest rates in Japan were near zero for an extended period of time. To search for higher yields from these low rates in bank deposits, investors used money market funds for short-term deposits instead.

However, several money market funds fell off short of their stable value in due to the bankruptcy of Enron , in which several Japanese funds had invested, and investors fled into government-insured bank accounts.

Since then the total value of money markets have remained low. Money market funds in Europe have always had much lower levels of investments capital than in the United States or Japan.

Regulations in the EU have always encouraged investors to use banks rather than money market funds for short-term deposits. One such condition involves a side-test calculation of the NAV that uses the market value of the fund's investments.

Breaking the buck has rarely happened. Up to the financial crisis , only three money funds had broken the buck in the year history of money funds. It is important to note that, while money market funds are typically managed in a fairly safe manner, there would have been many more failures over this period if the companies offering the money market funds had not stepped in when necessary to support their fund by way of infusing capital to reimburse security losses and avoid having the funds break the buck.

This was done because the expected cost to the business from allowing the fund value to drop—in lost customers and reputation—was greater than the amount needed to bail it out. An argument has been made that FMDI was not technically a money market fund as at the time of liquidation the average maturity of securities in its portfolio exceeded two years.

Prior to the adoption of this rule, a mutual fund had to do little other than present itself as a money market fund, which FMDI did. Seeking higher yield, FMDI had purchased increasingly longer maturity securities, and rising interest rates negatively impacted the value of its portfolio. This was only the second failure in the then year history of money funds and there were no further failures for 14 years.

The fund had invested a large percentage of its assets into adjustable rate securities. As interest rates increased, these floating rate securities lost value.

This fund was an institutional money fund , not a retail money fund , thus individuals were not directly affected. No further failures occurred until September , a month that saw tumultuous events for money funds. However, as noted above, other failures were only averted by infusions of capital from the fund sponsors.

Money market funds increasingly became important to the wholesale money market leading up to the crisis. Their purchases of asset-backed securities and large-scale funding of foreign banks' short-term U. The week of September 15, , to September 19, , was very turbulent for money funds and a key part of financial markets seizing up.

On Tuesday, September 16, , Reserve Primary Fund broke the buck when its shares fell to 97 cents after writing off debt issued by Lehman Brothers. Continuing investor anxiety as a result of the Lehman Brothers bankruptcy and other pending financial troubles caused significant redemptions from money funds in general, as investors redeemed their holdings and funds were forced to liquidate assets or impose limits on redemptions.

Through Wednesday, September 17, , prime institutional funds saw substantial redemptions. In response, on Friday, September 19, , the U. Department of the Treasury announced an optional program to "insure the holdings of any publicly offered eligible money market mutual fund—both retail and institutional—that pays a fee to participate in the program". This program only covered assets invested in funds before September 19, , and those who sold equities, for example, during the subsequent market crash and parked their assets in money funds, were at risk.

The program immediately stabilized the system and stanched the outflows, but drew criticism from banking organizations, including the Independent Community Bankers of America and American Bankers Association , who expected funds to drain out of bank deposits and into newly insured money funds, as these latter would combine higher yields with insurance.

The crisis, which eventually became the catalyst for the Emergency Economic Stabilization Act of , almost developed into a run on money funds: Thus there was concern that the run could cause extensive bankruptcies, a debt deflation spiral, and serious damage to the real economy , as in the Great Depression.

The drop in demand resulted in a "buyers strike", as money funds could not because of redemptions or would not because of fear of redemptions buy commercial paper, driving yields up dramatically: This is a bank run in the sense that there is a mismatch in maturities , and thus a money fund is a "virtual bank": Thus if there is a sudden demand for redemptions, the assets may be liquidated in a fire sale , depressing their sale price.

An earlier crisis occurred in —, where the demand for asset-backed commercial paper dropped, causing the collapse of some structured investment vehicles. As a result of the events, the Reserve Fund liquidated, paying shareholders The Investment Company Institute reports statistics on money funds weekly as part of its mutual fund statistics, as part of its industry statistics, including total assets and net flows, both for institutional and retail funds.

In the United States, the fund industry and its largest trade organization, the Investment Company Institute, generally categorize money funds into the type of investment strategy: A fund that invests generally in variable-rate debt and commercial paper of corporations and securities of the US government and agencies.

Can be considered of any money fund that is not a Treasury or Tax-exempt fund. The fund invests primarily in obligations of state and local jurisdictions "municipal securities" generally exempt from U. Federal Income Tax and to some extent state income taxes.

Institutional money funds are high minimum investment, low expense share classes that are marketed to corporations, governments, or fiduciaries. They are often set up so that money is swept to them overnight from a company's main operating accounts. Large national chains often have many accounts with banks all across the country, but electronically pull a majority of funds on deposit with them to a concentrated money market fund. Retail money funds are offered primarily to individuals.

Fund yields are typically somewhat higher than bank savings accounts , [ citation needed ] but of course these are different products with differing risks e. Since Retail funds generally have higher servicing needs and thus expenses than Institutional funds, their yields are generally lower than Institutional funds. SEC rule amendments released July 24, , have 'improved' the definition of a Retail money fund to be one that has policies and procedures reasonably designed to limit its shareholders to natural persons.

Recent total net assets for the U. Fund industry are as follows: Total Institutional assets outweigh Retail by roughly 2: The largest retail money fund providers include: Fidelity , Vanguard Nasdaq: Banks in the United States offer savings and money market deposit accounts , but these should not be confused with money mutual funds. These bank accounts offer higher yields than traditional passbook savings accounts , but often with higher minimum balance requirements and limited transactions.

A money market account may refer to a money market mutual fund, a bank money market deposit account MMDA or a brokerage sweep free credit balance. Ultrashort bond funds are mutual funds, similar to money market funds, that, as the name implies, invest in bonds with extremely short maturities. Unlike money market funds, however, there are no restrictions on the quality of the investments they hold.

Instead, ultrashort bond funds typically invest in riskier securities in order to increase their return. Enhanced cash funds are bond funds similar to money market funds, in that they aim to provide liquidity and principal preservation, but which: Enhanced cash funds will typically invest some of their portfolio in the same assets as money market funds, but others in riskier, higher yielding, less liquid assets such as: These are typically available only to institutional investors, not retail investors.

The purpose of enhanced cash funds is not to replace money markets, but to fit in the continuum between cash and bonds — to provide a higher yielding investment for more permanent cash. That is, within one's asset allocation , one has a continuum between cash and long-term investments:.

Enhanced cash funds were developed due to low spreads in traditional cash equivalents. There are also funds which are billed as "money market funds", but are not 2a-7 funds do not meet the requirements of the rule. A deconstruction of the September events around money market funds, and the resulting fear, panic, contagion, classic bank run , emergency need for substantial external propping up, etc. It has long been understood that regulation around the extension of credit requires substantial levels of integrity throughout the system.

To the extent regulation can help insure that base levels of integrity persist throughout the chain, from borrower to lender, and it curtails the overall extension of credit to reasonable levels, episodic financial crisis may be averted. In the s, money market funds began disintermediating banks from their classic interposition between savers and borrowers.

The funds provided a more direct link, with less overhead. Notably, the Fed is itself owned by the large private banks, and controls the overall supply of money in the United States. The OCC is housed within the Treasury Department, which in turn manages the issuance and maintenance of the multi-trillion dollar debt of the U. The overall debt is of course connected to ongoing federal government spending vs.

Unquestionably, the private banking industry, bank regulation, the national debt, and ongoing governmental spending politics are substantially interconnected.

Interest rates incurred on the national debt is subject to rate setting by the Fed, and inflation all else being equal allows today's fixed debt obligation to be paid off in ever cheaper to obtain dollars. The third major bank regulator, designed to swiftly remove failing banks is the Federal Deposit Insurance Corporation , a bailout fund and resolution authority that can eliminate banks that are failing, with minimum disruption to the banking industry itself.

They also help ensure depositors continue to do business with banks after such failures by insuring their deposits. From the outset, money market funds fell under the jurisdiction of the SEC as they appeared to be more like investments most similar to traditional stocks and bonds vs.

Although money market funds are quite close to and are often accounted for as cash equivalents their main regulator, the SEC, has zero mandate to control the supply of money, limit the overall extension of credit, mitigate against boom and bust cycles, etc. After adequate disclosure, the SEC adopts a hands off, let the buyer beware attitude.

To many retail investors, money market funds are confusingly similar to traditional bank demand deposits.