If you think the money in your money-market mutual fund is as safe as the cash in an FDIC insured bank account, think again.
Although money funds have been very safe investments in the past, there's always the possibility they could drop in value or "break the buck".
Federal regulators are considering new rules that could impact the cash you park in money-market funds. But it looks like the targets at this point are funds catering only to corporations and other large institutional investors.
First, some history.
Money-market funds were created 40 years ago to give savers a chance to make more money than what they collected from their local bank or thrift. In general, they invested in slightly more risky debt.
Largely overlooked was the fact that the funds were not guaranteed by the federal government. Even to this day, many erroneously believe money-market funds are protected just like bank accounts. That's one of the reasons the Securities and Exchange Commission is considering new regulations.
Despite the absent guarantee, nearly $3 trillion resides in these funds. About $1 trillion belongs to small investors. The funds became popular because you earned a little more interest than conventional accounts.
Until five years ago, only one tiny fund ran into trouble. Because that was so far back, in 1974, these funds seemed as safe as Fort Knox.
But an enormous fund – actually the first U.S. fund ever to offer money-market funds in the U.S. – ran into serious trouble. In 2008, the Reserve Primary Fund loaned too much cash to Lehman Brothers, an investment house that went under.
Breaking the buck
Instead of getting what seemed a certain $1 back for each $1 invested, savers got back only 97 cents. A panic erupted, and roughly $300 billion was withdrawn from the money-fund industry.
The government stepped in, restoring order by offering a temporary guarantee on the money. It has taken the SEC five years to propose rules that a majority of the body’s five commissioners could back.
Last year, SEC commissioners considered a proposal to allow breaking the buck for all funds. The funds fought back, fearing investors would leave in droves. A compromise was reached. The proposal on the table now would apply only to funds accessible by million-dollar players.
The first new rule would allow the funds to break the buck when necessary.
Second, the funds would be able to limit withdrawals and in certain cases charge a fee for withdrawals
The rules are not in force yet. The public can comment on the proposals for 90 days before any changes become effective. You can bet money funds and big investors will lobby like crazy.
A year ago, a “break the buck” rule covering all investors fell one vote short. As time passes, new commissioners could look more favorably on last year’s proposal.
But everyone should realize money funds are not guaranteed. And everyone should keep an eye on the SEC.