Straight Story: Fall of the money market

Economics editor Chris Farrell

TEXT OF COMMENTARY

TESS VIGELAND: One of the most fundamental questions that came out of last fall's economic meltdown was, is my money safe anywhere?

As our 401ks imploded and our banks teetered on the brink of collapse, we actually wondered if it was time to go to the mattresses. Money we had in the stock market simply vanished. But savings and checking accounts stayed safe. Another traditionally safe haven, however, failed us.

And in this week's Straight Story, economics editor Chris Farrell says it's time to say bye-bye to the money market mutual fund.


Chris Farrell: The other day I had some extra savings. It's money I can't afford to lose. Over the past three decades, I would have put it into my money market mutual fund without even thinking. Yet I sent the money to my bank savings. I had closed my money fund earlier this year and I won't open up another.

The reason is that money market funds are no longer a safe enough parking place for cash. The industry doesn't want to acknowledge it. Regulators are trying to avoid the issue. Yet for many conservative savers it's simply too risky a product.

It's hard to imagine now, but the money fund was one of the great innovations from the Age of Inflation. In the late '70s and early '80s, it was the hottest investment for middle class savers. Regulations at the time prevented banks from offering savers anything over 5.25 percent. But market interest rates were at double-digit levels. Money funds could pay those rates -- 11 percent, 12 percent and so on.

Long-time financial journalist Joseph Nocera says the question at the time wasn't, "Do you dare to risk your money in such a fund?" It was, "How could you not risk your money in a money fund?" In 1980, investors had poured $84 billion into money funds. Two years later, that sum had swelled to $200 billion.

Money funds gradually evolved into a staid investment haven for cash. The industry pledged that a dollar invested in a money fund would be worth a dollar no matter what. It worked for a long time.

That is, until the fall of last year. The industry broke its word during the darkest days of the credit crunch. When money market fund values started falling below a buck, taxpayers had to rescue the industry.

You can't trust the money fund "We won't break a buck" pledge anymore. How do we know our savings won't vaporize during the next financial crisis? We don't. The money in a fund is at risk.

Yes, I know, the SEC has proposed several changes to boost investor confidence, but these are minor reforms.

There are good ideas out there. Jane Bryant Quinn, the dean of personal finance journalists, recently got to the core of the issue. She called for a dramatic overhaul of the business. Money funds that want to say a dollar is a dollar should become like banks with government insurance. Funds that don't want to go that route should say share values will fluctuate. There's nothing wrong with that. Just make it clear that there's a speculative element to the investment.

It's frustrating that once again the interests of consumers and savers aren't front and center with Wall Street regulators and industry leaders. For now, I trust the Federal Deposit Insurance Corporation. I know my emergency savings are guaranteed even if my bank goes belly up. The same can't be said for money funds. That's why I've decided to label money funds the "Caveat Emptor Product of the Week."

About the author

Chris Farrell is the economics editor of Marketplace Money.

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