Ask Money

Money market mutual funds

Chris Farrell Sep 19, 2008

Question: If the government is now going to insure money market funds, will the return go down as the risk does? Carolyn, Tallahassee, FL

Answer: Yes, the return should go down. It’s an axiom of modern finance theory that the only way to create the potential for earnings a higher rate of return is by taking on greater risk. Money market mutual funds, which weren’t covered by the FDIC, paid investors more than comparable FDIC insured deposits.

Now, the federal government has created the equivalent of the FMMMFIC–the Federal Money Market Mutual Fund Insurance Corporation. Of course, that really means the American taxpayer is backstopping the $3.5 trillion in money market mutual funds for the next year. (It also means that everyone–like me–who accepted a lower yield on their money market fund in return for parking emergency money in the most conservative option paid an unnecessary interest rate penalty. Those that reached for yield just got bailed out.)

The federal guarantee that money market mutual funds won’t “break-a-buck” is for a year. But there is no way to put this financial genie back in the Wall Street bottle. Everyone knows the government will bail out the money fund business the next time trouble hit. What the year does is buy the authorties time to come up with a new regulatory scheme that takes into a account the federal government’s explicit guarantee of our short-term savings.

For more information, check out Tess’ conversation on money market funds with Marketplace’ s Amy Scott on this week’s Marketplace Money.

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