I still follow Joe Nocera’s column and I feel the need to respond to his most recent article, It’s Time to Admit That Money Funds Involve Risk. The difference between having my responses on his site and having them on mine….. besides reaching about fourteen million readers, is that now I get to write as many words as I think it takes to tell the whole story.
Joe needs to recollect Tim Geithner’s response to the question: What do the banks owe this nation? The government guarantee that the money funds would not “break the buck” is a perfect example of government intervention to restore confidence and prevent disaster, all at no real or apparent cost to the taxpayer.
It is not the “average Joe” who has their money in money market funds. These investors are substantially more savvy than the average American that opens a savings or money market account with a bank. And to imply that they are led to believe that there is safety in the Money Market Fund product is ridiculous. These investors knew better…. and know better.
So here’s my take on Money Market Funds.
First, there are some banking rules that you need to know. Banks, by federal law cannot pay interest on checking accounts. Not surprisingly, this is one federal regulation that the banks don’t violate. With the exception of NOW accounts that have always paid a miniscule amount of interest to the individual, sole proprietor and not-for-profit business, banks reap the rewards and profits that come from checking accounts. They pay you nothing and they earn a lot on them by lending it back to you through credit cards at 30% interest.
Banks also have to reserve ten percent of all checking account deposits. That means that they have to keep those funds on hand, ready to pay the checks you write. When they pay interest on an account, like a savings or money market, they have to limit the number of transactions on those accounts to six per month. So the average individual and business owner cannot earn interest on their liquid bank checking accounts and are severely limited in the number of checks they can write on their bank money market account. Therein lies the difference between a checking account, a bank Money Market Account and a Money Market Fund.
The first Money Market Funds popped up in brokerage houses. If you had your account with say, Merrill Lynch, you could open a Money Market Fund and earn market rates AND write as many checks as you wanted. As a banker, I’ve been competing with this account for twenty years. So imagine this: In 2006 a liquid Money Market Fund was paying about 4.25%. A bank money market about 3%. And a bank checking account …. Zero.
If you are a savvy investor and if you don’t need the services of the bank to take your deposits, cash your payroll and petty cash checks, provide you with coin and currency, etc. you opened your “business operating account” (alias Money Market Fund) with a brokerage firm and earned interest. If you needed these other services, then you opened a small checking account with the bank and kept the rest of the funds in the Money Market Fund….earning interest.
It’s important to note that the Fund Manager or Broker, receives fees for managing these portfolios of investments, typically between 1% and 1.5%. The investor’s return is AFTER these fees are deducted.
In 1999, with the repeal of the Glass-Steagall Act, the playing field was leveled. Banks bought investment firms or partnered with outside investment firms and began to offer these Money Market Funds in their retail stores and business banking centers.
Still, they are not products that are well advertised. The banks want employees to bring in accounts as checking accounts that pay no interest. Only if we are unable to win the business by offering conventional bank products, are we then allowed to ‘sell’ these Money Market Funds to our customers. The idea behind this is that the bank makes more money by using the depositors checking account funds than they make on the management fees on the Money Funds. Has anyone in this country ever received a mailing from their bank recommending that they convert their checking to a Money Market Fund. Never!
Along with this product line comes pages of disclosures and a Prospectus. Still, it baffles my mind how the SEC can allow this product to be sold in the retail bank by unlicensed folks like myself. But they were, and they are. Our regulators once again turn their back on the laws they are obliged to enforce. But I digress.
The consumer or business owner, selecting this product receives and signs all sorts of documents with the following types of disclosures:
Risk Factors for all Mutual Funds
Please remember that an investment in a mutual fund is:
Not guaranteed to achieve its investment goal
Not a deposit with a bank
Not insured, endorsed or guaranteed by the FDIC or any government agency
Subject to investment risk
Although the Fund seeks to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in the Funds.
What part of this can be misinterpreted?
The Dollars and Sense of it:
Let’s take the most conservative of these Money Funds: The Treasury Money Market Fund and look at the return to the investor that kept an average of $50,000 in balances. The average ANNUAL RETURN from 1994-1998 was 4.74%, and from 1999 to 2003 it was 2.76%. I can’t give more updated numbers because I’m taking them from a prospectus released in 2004. Still, these levels of returns remained through at least 2006.
This Money Market Fund investor earned $18,750 on their $50,000 liquid account over ten years, used the account in lieu of a bank checking account and were able to write an unlimited number of checks. The same bank depositor that had a checking account earned …. Zero.
If the fund breaks the dollar and drops even as low as $.90 per share, they would lose $5000 of their $50,000 investment and are still ahead $13,750. They had all the disclosures and were a type of investor that knew the rules and the risks.
On a larger scale, if these funds hold 3.5 Trillion dollars in assets, under management, the management fees which average at least 1% provide a minimum of THIRTY BILLION dollars a year in income to the Wall Street Fund Managers. With these types of returns enjoyed these many past years, perhaps they should be the ones to step up to the plate and provide the guarantee.
I have a hard time feeling sorry for these folks. Nonetheless, I still have to agree with the government’s decision to temporarily provide a guarantee against “breaking the buck” and return confidence to the people. But now, more than ever, these investors have been warned and going forward they must evaluate their risk and act accordingly.