When I entered the Investment business about 32 years ago, the big story of the day was how Merrill Lynch had invented a new type of product called the Cash Management Account or CMA. This account was a marriage of a new instrument called a money market with the old fashion idea of a checking account. Now, one could earn the high rates of a money market account and write checks at the same time.
Back then, even though interest rates were at their highest levels in history----13, 14, 15, and in some cases 20%, banks were limited in the amount of interest they were allowed to pay on their checking and savings accounts. Merrill Lynch took full competitive advantage of this and created the account I just described. What transpired was a revolution in the way people used their brokerage accounts and the way brokerage firms were perceived.
Money Market Funds were relatively unknown to the general public at that time and as the story goes, people lined up around the block at Merrill Lynch to open up new accounts and earn these incredibly high interest rates.
The most important aspect of these new money market funds which by the way, are really mutual funds that invest in very short term bonds issued by very high-rated corporations, was the simple fact that one could buy shares priced at $1.00 and redeem those shares at any time for $1.00 per share. Any change to the value of fund was made by adjusting the interest rate paid, not the price. Investors therefore, could feel certain they would get the return of their principal on-demand just like a checking or savings account. This was a very attractive proposition: earn a very high interest rate with no risk to principal. What could be better?
This has been the arrangement until now, and the reason I am writing about it today. There is a big change coming that is going to alter the money market industry and I want you to know about it.
It has been announced by the large brokerage firm, Charles Schwab, that the share price of their money market will now float based on the value of the underlying securities. No longer will the share value continue to artificially stay at $1.00 when the values of the underlying securities are worth less.
Why this new change? The move to change came during the financial crisis of 2008. Surprised investors had to hurry to pull cash out of a well know small money market fund called the Reserve Primary Money Market Fund after it was disclosed that the fund owned a lot of Lehman Brothers paper. The fund, being relatively small in size had to adjust the price per share of its money market which, in the industry is known as "breaking the buck". Breaking the buck was something a money fund was just NOT supposed to do. Doing so would undermine the whole idea of safety with high yield.
Interestingly, it was later uncovered that 21 money market funds were in a similar situation. Yet, nothing happened because fund sponsors supported the value of the fund with their own money. This led Mary Shapiro, chairman of the SEC to push for reform to make the industry more transparent and more liquid. One feature she wanted changed was to demand that money market funds begin to "float" their share price in order to fully reflect the underlying value of the securities held. A good idea, but one that generated a lot of backlash by the fund industry. The industry feared that large and small investors would turn away from money market funds causing a massive outflow of capital. This could lead to a serious disruption of this multi $trillion industry, affecting not only the funds themselves but the corporations relying on these funds to raise money.
It is feared that "reverse-disintermediation" would take place. Reverse disintermediation is the act of putting money back into bank savings and checking accounts and pulling them out of your brokerage account money market, the exact opposite of what happened in the 1980s when money came out of the banking system and swept into the brokerage world.
In spite of all this, it seems as if money market sponsors are changing their minds.
It was announced recently that Charles Schwab Corp and other large fund sponsors are submitting proposals to let the share price of their money market funds to float, These other funds are run by Fidelity, JP Morgan Chase and Co and Federated Investors Inc. and others. Reuters has reported a plan by Schwab to provide "daily disclosures of their net asset values (another name for share price)".
So far, share prices have not changed from $1.00. Since money markets funds invest in very short term corporate bonds, treasuries or tax exempt municipal bonds, bond price changes are negligible. It is only in times of great crisis like 2008 that share prices could be affected.
What You Should know and What You Should Do.
You should know your money market share value has been fluctuating all along, but firms have been keeping the share price artificially set at $1.00. Now, this ruse is over and you may begin to see your share price fluctuate to reflect its true value. Start watching your money market and discuss this with your financial advisor or your brokerage firm representative to get a clear picture of what it means to you.
Fundamentally it is my belief that money market funds are very safe and I would not expect the share value to fluctuate very much- if at all. However, during times of stress this could change so consider changing your money market fund to one which invests in US treasury securities or tax exempt bonds. With interest rates so low, you will not lose any interest because, frankly, you're not earning any interest anyway.
Remember, transparency is a good thing, and while it adds one more item to your checklist, it could give you enough information to make the best decision for your future. Knowledge is power but you need to exercise your power in order for it to change your life.
Steve Pomeranz is a Managing Director for United Capital Financial Advisers, LLC, "United Capital", and owner of On The Money. On The Money is not affiliated with United Capital.