A note on money market funds

A few people have asked me about money market funds and whether we should start worrying about their safety. Last week's news of the Prime Reserve fund "breaking the buck" added to the worries of the week's unfolding disasters. This fund in particular wrote down the market value of some Lehman securities it owned which resulted in a 3 penny loss in net assets value from $1 to $.97, or a 3% loss. An investor who held the fund for a year probably had earned about 4% in interest payments over the course of the year and so netted against the 3% loss is still up about 1% for one year. In the whole scheme of things, this isn't the worst thing that could happen. However, money market funds' $1 net asset value (NAV) is held sacred by investors and money market providers alike. In the past when a money market fund faced the predicament of losing value, usually the mutual fund provider injected capital to make up for any loss. Presently, this option may be difficult given the current liquidity crisis in the fixed income markets. However, I believe that mutual fund companies like Vanguard, Fidelity and TRowe Price in particular would be in a position to infuse capital to one of their money funds if necessary as they have escaped many of the problems that have plagued the banks and investment banking firms who have been writing off bad mortgage loans and bonds backed by bad mortgage loans. To safeguard any further issues with losses in money market funds, the government has made insurance available for purchase by any provider that wants it--up to 50 billion in insurance is available. All of the steps taken by both the Treasury and the Federal reserve have been done to restore confidence in the financial system. So be confident.

On another note, the SEC has banned short selling on 799 financial stocks until October 2, 2008. While some (especially short sellers) think this step draconian, I do think it is the right action at this time. Hopefully the SEC will reinstate the uptick rule which forces anyone who wants to sell any stock short to wait for an uptick in price before selling. This does mitigate downward spiral of stock price in a bear market as it just "slows down" trading and pessimism. The uptick rule was eliminated last year---I don't know why. The short sellers are I believe partly to blame for this fiasco because lower stock prices mean that companies, like AIG, cannot raise adequate capital in the equity markets: their stock price is too low.

I think we are headed in the right direction with the Treasury trying to get Congress to pass a bill that will ultimately buy all of these bonds that no one seems to want. What this will cost to US productivity and economic growth in the long term remains to be seen. It is kind of like trying to put out a 5 alarm fire and worrying about what the water damage will be--can't worry about that now, let's just put out the fire.

Better days are coming...may they get here soon.