Money market funds, usually considered nearly as safe as cash, are suddenly in the spotlight. Why? Millions of Americans hold money market funds, which invest heavily in foreign banks.
With protests roiling Greece, which teeters on the brink of national bankruptcy, many investors are suddenly wondering how vulnerable they are.
Most of the funds have virtually no direct Greek holdings. On the other hand, many have loaned out significant amounts of money to European banks that do have loans to Greece. Unless the Greek Parliament agrees to make sharp budget cuts, major European nations, including Germany and France, have said they will not make any more loans to Greece, which would drive the country to the edge of default.
So, how safe are investments in money market funds?
In a recent analysis, credit researchers at Fitch Ratings found that 50 percent of the assets of the 10 largest prime money market funds – those that invest in vehicles other than government debt – were invested with European banks though their American subsidiaries. This would mean about $800 billion is loaned out to such banking giants as Deutsche Bank, ING, Barclays and BNP Paribas. Most of those banks are borrowing money in the US, since short term interest rates are so low here.
Fitch found that the money market funds had 6.3 percent of their exposure to German banks, 14.8 percent to French banks and 9.7 percent to United Kingdom banks.
How vulnerable are those European banks? According to the Investment Company Institute (ICI), the actual exposure of European banks to Greek debt is relatively small. The most vulnerable bank has about 1 percent of its assets, and less than 10 percent of its capital, in Greek debt.
“If there was a total loss on Greek debt, the bank would lose 1 percent of its assets,” says Mike McNamee, an ICI spokesman. “That would not tank the money market funds.”
Past efforts to stabilize money market funds
Many investors remember that during the financial crisis in 2008, one money market fund, the Reserve Fund, fell below the sacrosanct net-asset-value of one dollar, because the fund had loaned out hundreds of millions of dollars to Lehman Brothers. To avoid a catastrophe, the Federal Reserve guaranteed the assets of the rest of the money market funds.
Six months later, Mr. McNamee notes, the industry voluntarily changed its own standards. Money market funds must now be able to tap 10 percent of their assets overnight and 30 percent within a week.
But regulators are still concerned. Last week, Chairman Ben Bernanke of the Federal Reserve announced at a press conference that the Fed and other regulators “are continuing to look at ways to strengthen money market mutual funds.”
Last January, McNamee says, the industry spent a lot of money to develop new proposals for the regulators. “So far, the regulators have not settled on any particular proposal,” he says.
Some investors say the problems in Greece, as well as Portugal and Ireland, are worrying them. If the banks and insurance companies who have made loans to those countries have to take losses, it could adversely affect capital levels of the European banks, says Mark Lamkin, chief investment strategist at Lamkin Wealth Management in Louisville, Ky.
“We’re not out of the woods yet,” says Mr. Lamkin, whose fund is investing its cash in insured money market funds – most funds are not insured – and US Treasury securities.
Another investor, Eric Stein, a portfolio manager at Eaton Vance, says a major concern of American investors is that the European banks have been slow to write off bad loans. Last year, the European banks performed a “stress test” which was viewed with great suspicion by the financial markets. Now the banks are doing another test – results are expected in July – which is supposed to be more transparent.
“They need to make it credible,” says Mr. Stein, who has worked at the New York Federal Reserve Bank.
Is this all much ado about nothing?
Not everyone anticipates a run on European banks.
If losses began to loom, the European Central Bank, the equivalent of the US Federal Reserve, would likely step in and bail out the commercial banks, says Axel Merk, president of the Merk Funds in Palo Alto, Calif.
“I do think they are too big to fail. Everybody would be all bailed out,” says Mr. Merk, whose funds invest in gold and currencies such as the Euro.
In a worst-case scenario, Merk says the money market funds could stop redemptions and pay the principal back – assuming the Central Bank stepped in.
Other money market fund observers agree that the threat is overblown.
“The debate surrounding MMF [money market fund] risk has veered dangerously from the realm of reality into the realm of rhetoric,” testified Mercer Bullard, head of Fund Democracy, Inc. and a law professor at the University of Mississippi School of Law, at a House subcommittee hearing.
Professor Bullard believes concerns over funds’ short-term holdings of European banks “are misleading.” He was particularly incensed over warnings by Eric Rosengren, the president of the Federal Reserve Bank of Boston, who recently stated that money market funds “still remain vulnerable to an unexpected credit shock that could cause investors to doubt the ability to redeem at a stable net asset value.”
Bullard says funds have experienced frequent “unexpected credit shocks” and survived all but one – the 2008 collapse. He maintains there has been no “empirical analysis” of the actual risk posed to the funds by their holdings of European bank debt.
Europeans regulators and political leaders seem determined to solve the problem, even if only temporarily. On Monday, French banks said they were willing to roll over the Greek sovereign debt and give Greece more time to repay their loans.
“It gives a good road map for other financial institutions to follow,” said Mark Zandi, senior economist at Moody’s, at a Monitor breakfast on Tuesday. It will help to “kick the can down the road,” says Dr. Zandi. “I do think the European leadership understands a near-term default would be a very serious problem, and they don’t want to go down that path.”