Moody's: Money Market Accounts Were in Worse Trouble Than We Thought

Just about two years ago, the Reserve Primary fund, housed at one of America's oldest money-market operations, broke the buck.  That is, the assets in the fund took a nosedive, to a value well under $1.00 a share.  Money markets strive hard to maintain the $1=1 share relationship (any interest or capital gains on the assets in the fund are what gives the money market its yield).  That's what makes these funds look very similar to a bank account: you always get out at least what you put in.  When a fund breaks the buck, it's as if Citibank suddenly told you that your savings account only had $587 in it instead of the $900 you deposited.

As with bank accounts, losing the money you deposited is now so rare that when it happened, people panicked. The ensuing run on the money markets was arguably the worst moment in the financial crisis, and like many people, I believe that this, more than any other event, irrevocably committed the government to massive intervention in the financial sector.

I've been told by multiple sources that even before the Reserve Primary debacle, a number of firms had been quietly "topping up" their own money-market funds to keep them from breaking the buck.  Indeed, as I understand it, the only reason that Reserve Primary broke the buck was that it was a small firm catering mostly to institutional investors; when the commercial paper markets went haywire, there was no parent company with deep pockets to keep it from going under.

Now a report from Moody's seems to confirm this, and suggests that the practice was even more widespread than I'd thought:

According to our research, 62 funds, including at least 36 funds in the US and an estimated 26 funds in Europe, received financial and balance sheet support from their sponsor or parent company during the financial crisis between August 2007 and December 31, 2009 . . .

During this interval and continuing into 20109, at least 20 firms managing prime funds in the US as well as Europe expended a minimum of about $12.1 billion dollars (pre-tax) to preserve the net asset values of their CNAV funds due to credit losses, credit transitions or liquidity constraints10 . . . On average, this represents a staggering $607 million pre-tax, per firm on average, ranging from a low of $27 million to a high of $2.9 billion reported by one firm. What's more, at least two fund management firms relied on parent company balance sheets and access to the Federal Reserve window to provide liquidity to meet unexpectedly outsized redemptions and at least two firms consolidated money market fund assets onto their balance sheets . . .

Moreover, it seems to have been happening long before the crisis hit; presumably firms figured they'd lose less money by making good the losses than they would by alienating customers who lost money on a "sure thing".

Moody's goes onto suggest that larger funds, less liquidity, and historically low interest rates make it less likely that funds that do break the buck will be topped up in the future.  The funds are now less like bank accounts than like, well, slightly risky investments in short-term securities.

Of course, you only need to worry if your money market is offered by an investment house.  The money markets offered by banks--known as Money Market Deposit Accounts--are now insured by the FDIC.