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August 22, 2007 at 08:00 PM
Money market funds–something almost everyone takes for granted–are not supposed to be newsworthy. But during the first two weeks of August. Standard & Poor’s put securities from four corporate issuers on its negative CreditWatch list, which can be a warning of a potential problem with an issuer, or upcoming downgrade of a particular security. These are securities that were or are part of the portfolios of some money market funds.
Is it possible that there’s more risk in money market funds than we thought? How likely is it that some money fund will break the buck, and instead of standing behind the buck, will instead say to investors: Read the prospectus–the buck isn’t guaranteed? Years ago on the rare occasion that a money market fund had broken the buck, sponsors have stood behind the $1.00 NAV and made investors whole.
As advisors well know, money market fund prospectuses generally say that they seek to preserve the NAV at $1.00, but that they are not FDIC insured and therefore investors could lose money by investing in the funds. But “there is no contractual guarantee,” though the repercussions for investors and fund companies would certainly be enormous if investors felt that they couldn’t trust the “implicit guarantee” of the buck NAV for money funds, says Bruce Bent, father of the money market fund, and founder and chairman of The Reserve, a cash management company in New York, New York. Bent’s firm created the first money management fund in 1970. The Reserve now has over $70 billion in assets, with $5 billion added in the week before we talked with him, on August 17th.
Bent asserts that the whole subprime mortgage mess is misunderstood. “The total amount in the subprime market in 2006 is $800 billion,” in the mortgages, says Bent. He figures that if 20% of those subprime borrowers default, that’s $160 billion worth of mortgages, and if the lenders foreclose and sell the homes that collateralize those mortgages at 80% of their mortgaged amount, “now you have a 20% loss on $160 billion that winds up to [be] $32 billion,” but “there is $3 trillion in money market funds, so that’s a meaningless figure.”
