Is Your Cash Really Safe?

Before last year, nobody thought too much about money market mutual funds. But 2008's cataclysmic events brought the money market industry to the brink of destruction. Amid a recent resurgence of relative calm, the SEC met late last month to discuss the future of money market funds. At issue: what will happen to the fear-induced regulations of 2008, and what rules are appropriate in the somewhat calmer waters of today's markets.

Remembering the good old days
Money market mutual funds, which many people consider risk-free investments, have provided investors with safety, security, and modest income for years. Investing in short-term securities such as Treasury bills and commercial paper, these funds have done their best to keep their net asset value at $1 -- offering institutions a fundamental source of immediate financing while consistently avoiding losses for investors. Safe. Comfortable. Cozy.

Bam! September 2008!
But then came the near-collapse of the U.S. financial system. We all remember those mind-altering September mornings: Lehman Brothers filing for bankruptcy, AIG (NYSE: AIG) scrambling to borrow billions of dollars, and an overall wave of panic washing over consumers, investors, and Wall Street alike.

For the first time in 14 years, a money market fund "broke the buck" -- in other words, its net asset value fell to $0.97 a share. That represented an immediate 3% loss on what was traditionally considered an unbreakable investment. Shortly afterward, everyone began jostling frantically to shore up funds. Bank of America (NYSE: BAC), Legg Mason (NYSE: LM), and Wells Fargo's (NYSE: WFC) Wachovia all contributed capital to prevent their funds from breaking the buck themselves. Investors started fleeing to the safety of FDIC-insured bank savings accounts.

Here comes the government! We're saved...
Panic comes and goes. Last year, the Treasury Department and the Federal Reserve came swooping in to alleviate the public's concerns. On Sept. 19, the Treasury announced a $50 billion temporary guaranty program for money market funds to reassure investors. The Fed then expanded its emergency lending program to help financial institutions buy asset-backed securities from money market funds, in order to raise cash to pay back shareholders.

Over the past year, things have gotten more or less back to normal. Not necessarily cozy, but secure. The government's on our side. Guaranty programs and lending facilities have kept things quiet in the money market arena. And like most big banks and implicitly guaranteed institutions such as Freddie Mac (NYSE: FRE) and Fannie Mae (NYSE: FNM) -- the money market industry has suddenly become too big to fail.

Still safe...
By mid-September 2009, however, these guarantees are slated to expire. To help plan for the future, the SEC wants money market funds to behave differently going forward:

• All money market funds will be required to hold as much as 10% of their assets in securities that can be sold in one day or less.
• The maximum average maturity of securities held by funds will be cut from 90 days to 60 days.
• Funds will be allowed to suspend withdrawals should they break the buck, therefore allowing a more orderly liquidation.

So all is good -- right?
Wrong.

• First, we're still left with the question of whether money market funds should move toward a floating asset value model, or maintain their current stable net asset value model. Two of the biggest players in the industry, Vanguard and BlackRock (NYSE: BLK), have lobbied against the floating formula, expressing fears that investors will move their funds to vehicles that offer a fixed price.
• Second, money market funds remain heavily reliant on the credit rating agencies, since funds must still buy assets that earn a certain minimum rating. After the financial mess exposed their dubious practices, we now know just how little we can trust such agencies' ratings.
• Lastly, and most importantly, money market funds will continue to act as "shadow banks" -- implicitly promising the preservation of capital without the supervision or regulation of normal banks. Money market funds are observed by the SEC. On the contrary, banks typically face regulation on multiple fronts from entities including the FDIC, the Federal Reserve, the OCC, and state regulatory agencies.

Given that money market funds continue to claim status as a safe haven for investors, without abiding by the same rules and regulations that banks must obey, how protected do you feel? Let me know by leaving your comments below -- and stay tuned for future coverage.