The New Risks Facing Money Market Funds
The SEC’s reforms to money markets pushed cash to government funds. Now treasurers are concerned about concentration in those securities.
When the Securities and Exchange Commission enacted new rules designed to reform money market funds, few anticipated that investors would pull more than $1 trillion from higher-yielding prime funds, which include corporate securities, for money market funds that invest only in government instruments. Now, with talk of a potential government shutdown on Saturday, some big investors are concerned about the possible risks of having so much cash concentrated in one type of money fund. Unless lawmakers agree on a new spending bill, the U.S. government will run out of money on Friday, curtailing services. The last time a shutdown happened was in 2013, when both Republicans and Democrats used the spending bill — and the threat of closed doors for essential services — as leverage to get agreement on other measures.
Even though the Treasury markets are among the most liquid in the world, a temporary U.S. government shutdown could create delays in new Treasury issuance or other operations. Money funds, which allow investors to withdraw their cash at any time, invest in a range of debt instruments with maturities ranging from a few days to weeks or months. Corporate treasurers are concerned about any glitches in the Treasury Department’s ability to return principal and interest if a security matures during a shutdown. A hangup could force money funds to sell these securities at a discount in the open market.
And even if the process works perfectly, investors may rush to pull their cash from these funds in anticipation of problems. When that happens, money funds need to sell longer-duration securities to meet redemptions. With $1.4 trillion in cash parked in government funds these days, any selling could send prices down, a scenario that could be amplified now that money funds are so concentrated in government securities.
The Looming Debt Ceiling
Corporate treasurers and other money fund users say they are also concerned that debt ceiling discussions, which would not occur until the fall, could also affect the stability of government funds.
“Treasurers aren’t panicking, but there has never been a time with such concentration in government money funds,” says Frank Bannano, managing director and head of marketing for StoneCastle Cash Management, an institutional cash manager and investor in community banks. “If the government shuts down in the next couple of days, they may get spooked,” he adds.
One Treasurer at a large pharmaceutical company says he expects any problems to be short term and worked out within weeks, but he doesn’t want to take any risks with money intended for immediate expenses such as paying vendors and employees. He added that the shutdown threat raises concerns for him about how few options corporations have for short-term cash needs.
“We get paid to eliminate risk. If you’re managing cash and you’re doing it right, no one notices,” he says.
Sean Collins, an economist at the Investment Company Institute, a Washington, D.C. lobbying group for mutual funds, disagrees. He says the ICI doesn’t believe a shutdown would affect the normal operation of government funds, saying, “Treasurys are the safest and most liquid securities in the world.” But he added that any debate about raising the debt ceiling, which is required if the government reaches the maximum amount of debt it can issue, would pose a bigger issue for funds. In that situation, new Treasury issuance could come to a halt.
Still, Collins pointed out that government money market funds continued to function when Congress couldn’t reach an agreement on raising the debt ceiling in 2013. When Treasury halted operations, fund managers that couldn’t roll over matured debt instead sold the positions to buyers for a discount.
The SEC’s reforms, implemented last October, include a floating net asset value for prime funds that fluctuated in line with the value of securities in the portfolio. A floating NAV, the SEC reasoned, would give investors a true picture of the value of their money fund holdings. The intent was to prevent a repeat of the crisis in 2008 when the Reserve Primary Fund broke the buck — meaning its price fell below $1.00 — when the fund experienced losses from the Lehman Brothers bankruptcy. Though not a regulatory requirement, money funds had historically kept their NAVs at $1.00 regardless of losses in the portfolio. Reserve Fund’s loss prompted a wave of withdrawals from money funds and pushed the government to step in with temporary guarantees to stop the panic.
Prime funds have lost more than $1 trillion in assets since the SEC approved the reforms, hitting a low of $373 billion in October. Most of that money shifted to government funds, which could still maintain a $1.00 NAV under the SEC’s new rules. Government funds now have $1.4 trillion in assets, up from $900 billion in July, 2014, according to Bloomberg.