The Industry Doth Protest too Much, Methinks?

After hearing allegedly competent central bankers, Administration officials, banking leaders, state regulators, and conservative pundits say otherwise, many people now realize that the troubles that festered in an isolated corner of the mortgage universe were actually the tip of the iceberg as far as the rot in our financial system is concerned.

Given that, cynics might view the myriad reassurances [highlighted in bold] in the following Wall Street Journal report, "Money Funds Feel the Credit Squeeze," as a cause of concern.

Turmoil in the mortgage and bond markets this year has caused tremors in one of the safest investments available to individuals -- money-market mutual funds.

But industry officials and financial advisers generally say there is little reason to worry.

Money funds aim to maintain a steady share price of $1, and pay income from their holdings of high-quality, short-term debt securities. They are different from money-market accounts, which are bank accounts backed by the Federal Deposit Insurance Corp.

In an attempt to get higher yields, a number of money funds have in recent years bought some exotic -- but, at the time, high-rated -- securities, including those backed by mortgages. In recent months, some of these types of securities lost value, raising concerns about whether some of the funds might lose value and "break the buck," or have to lower their share price below $1.

No Losses This Year

That has not happened so far, thanks mainly to the fact that fund companies have stepped in to buy some troubled securities from their funds.

In fact, since the first money fund was founded in 1970, only one fund, marketed to institutions rather than individuals, is known to have broken the buck. In 1994, the Community Bankers U.S. Government Money-Market Fund shut and returned only 94 cents a share to investors, because of risky derivatives investments that regulators later prohibited.

The mutual-fund industry is focused on not letting money funds lose value, particularly to maintain the funds' reputation of safety. "I don't think the consumer is in danger at this point," says Connie Bugbee, managing editor of research firm iMoneyNet.

That's also the word from a leading fund-industry association. "Since the onset of the credit crisis in August, money-market mutual funds have been taking steps to ensure the safety and liquidity of their portfolios....They will continue to take action as market conditions warrant," says Paul Schott Stevens, president of the Investment Company Institute.

Despite some concerns about these funds, investors spooked by other kinds of investments have flooded money funds with new cash. The funds have taken in $524 billion so far in 2007, a record annual inflow that has raised their total assets to a record of more than $3 trillion, according to ICI.

The cash has come largely from investors, both individuals and institutions, that are seeking a "flight to simplicity, flight to quality," says Deborah Cunningham, head of the taxable money-market group at Federated Investors.

Money-fund assets have risen even as the Federal Reserve has trimmed short-term interest rates, cutting its target rate to 4.25% as of last week from 5.25% in August.

The average seven-day yield on taxable money funds has fallen to 4.16% last week from as high as 4.77% in April, according to iMoneyNet, and the latest Fed move is likely to produce lower yields over the coming weeks.

Special Money-Fund Math

Each day, stock and bond mutual funds must calculate their "net asset value," or the per-share market value of their portfolio holdings. That determines the price for investors buying or selling shares.

In contrast, money funds declare their NAV based on the purchase price of their securities, and then make periodic assessments that the per-share value of the portfolio securities is indeed very close to $1.

If the difference ever becomes 0.5% or more -- that is, if the per-share value of the portfolio is 99.5 cents or less -- the fund would likely have to cut its NAV and thus break the buck.

This year's money-fund troubles began in the summer, when some so-called asset-backed commercial paper, a type of short-term debt security, couldn't find buyers and started losing market value. Some money funds, such as those from Bank of America's Columbia Management Advisors, Wachovia's Evergreen Investments and U.S. Bancorp's First American Funds, held commercial paper from some issuers that in August said they couldn't pay back their debt on time.

Then, in October and November, concerns arose about securities issued by structured investment vehicles or SIVs. SIVs raise money by selling short-term debt and use it to buy higher-yielding long-term securities, including mortgage securities. As investors shied away from risky assets, even high-quality SIV debt became hard to trade.

Eventually, Wachovia, U.S. Bancorp and Bank of America bought some of the troubled commercial paper and SIV securities from their funds.

However, as of earlier this month, at least a dozen money funds were still holding some SIV securities that had been put on review for a possible ratings downgrade by Moody's Investors Service. A number of fund companies say these holdings are small portions of their funds, and they are comfortable that these holdings will ultimately be paid off.

Reducing SIV Debt

Money funds have lately been cutting back on their investments in SIV debt and are allowing securities to mature without rolling them into new debt from the issuers. Also, some of the SIVs' corporate parents, including Citigroup last week, are taking steps to support these securities.

Bruce Bent, creator of the first money-market fund and chairman of money-fund firm The Reserve, disapproves of some of the exotic securities some money funds have been buying. "People have taken the concept of money funds and corrupted it by investing in an SIV," he says.

He adds, however, that he "sincerely doubts" that any money fund will break the buck.

Comments

[Unscripted Thoughts]

Haven't broken the buck since 1994? Whoops...guess they missed this recent BoA announcement: "Columbia Management, which is a unit of Bank of America, is shutting down its Strategic Cash Portfolio, which is an "enhanced cash fund. The fund had roughly $34 billion, but it seems that some $21 billion wanted to redeem. Typically, such redemptions would be at $1 per share, just like a money market fund. But enhanced cash funds are not required to maintain a $1 per share valuation, which is why they are allowed to invest in riskier paper, like short term commercial paper from SIVs (Structured Investment Vehicles) backed by asset backed securities. So, technically B of A did not break the buck, as they were not required to maintain the value of the fund at $1." (Hatip: John Mauldin)

[Mario]

I wish to add one more point. The 'money market' funds bought this garbage only to subsidy his management fee. A cost of 0, 5% or so in a year drags more than 10% in a fund results when the interest are low. They did it to protect their revenues and careless about their investors!

[Mario]

I wish to add one more point. The 'money market' funds bought this garbage only to subsidy his management fee. A cost of 0, 5% or so in a year drags more than 10% in a fund results when the interest are low. They did it to protect their revenues and careless about their investors!