C&B Notes

Money Market Funds Aren’t What You Think

Permanent losses of capital can lurk in unexpected places.  We believe that the outlying events that can cause major disruptions for money market funds happen much more often than most think.

They [investors] don’t know that as recently as last summer, the largest money funds averaged 45% of their investments in European bank paper, with one major player at just under 70%.  They don’t know that, were the investments to falter, half of the top 10 money-fund providers are not large and presumably well-capitalized banks but instead asset managers that don’t have anything like banks’ capital resources.

Nor do money-fund investors know that the largest money-fund managers have been gaining share in the industry over time, therefore concentrating and potentially heightening the risk of a failure.  And they don’t know that, while these firms will likely go to extreme lengths to avoid “breaking the buck,” the $1 net asset value represents an implicit, rather than, guarantee.  Even then, there is no certainty that firms will be successful in raising capital in a downturn since, by definition, they will be trying to do so during a market dislocation.

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In short, if the industry wants to keep the guarantee as a “can-do” rather than a “must-do,” then a floating net asset value would go a very long way toward signaling that the investment principle is not guaranteed.

And if the industry wants to improve the safety of the business and of that guarantee, additional capital likewise goes a long way.  Nothing in financial services is as dangerous as a guarantee without capital backing it.  Think of the mortgage insurers and their guarantees of mortgage insurance, with very thin capital layers backing enormous promises.  Think also of the billions of dollars in disputed losses around this.  Better to provide that cushion for potential losses now, during a period of relative calm, than during or on the other side of the next market downturn, when it’ll be a much more expensive proposition.

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