Economy doesn't leave money market funds unscathed

As if the wretched stock market and cratering economy weren't enough, another occupant is in our closet of anxieties these days: money market mutual funds.

Money funds are a fixture of today's financial marketplace. Individual investors use them to park cash when moving between investments. Big institutions use them to collect interest on money they may hold only overnight. Consumers put savings in to earn a little interest, in accounts that offer checking privileges, too.

But all is not well with the historically reliable money fund industry.

The collapse of the Reserve fund, the nation's oldest money fund, was just the most visible problem in a string of industry missteps. The government scrambled to reassure investors that their money funds were safe, instituting a temporary insurance program for the funds in September.

But the insurance program is to expire April 30, and regulators are trying to figure out the best way to fix the industry.

With $3.9 trillion lent to the U.S. government, major banks and giant corporations, "The money market is the financing vehicle for every financial institution out there," says Cathy Roy, chief investment officer for fixed income at the Calvert funds.

Clamping down too hard on the money fund industry could cripple a vital part of the nation's financial system. Doing nothing means the possibility of another mass exodus from a money fund, which could prolong the credit crunch and bring down other companies.

"What is key now is to make sure that funds aren't reaching for yield — which is what got them into this mess in the first place," Roy says.

Breaking the buck

The $60 billion Reserve fund shocked the financial world when it announced that its share price would fall below $1 — "breaking the buck," in money fund parlance. The fund had invested in short-term IOUs issued by Lehman Bros., which collapsed at the same time.

Breaking the buck is the cardinal sin in the money market industry. Money funds try to keep their share prices at $1 every day, so investors don't have to worry about day-to-day price fluctuations and can treat their investment much like an interest-bearing checking account.

Before Reserve, only one tiny institutional fund had broken the buck, in 1994. And, because the Reserve was run by Bruce Bent, the inventor of the money fund and a critic of the risks other money funds took, the shock was even worse.

In reality, investors shouldn't have been shocked.

Since the credit crisis began in 2007, more than two dozen companies that manage money market funds have had to step in and buy up their money funds' bad investments. Among the companies that have shored up their funds: Dreyfus, Columbia, Northern Trust, HSBC, Legg Mason, Wells Fargo, SEI, Allianz Dresdner, Bank of America and Evergreen.

"The fact that there have been deep pockets has substantially helped keep problems from trickling down to shareholders," says Doug Scheidt, associate director for the Securities and Exchange Commission's Division of Investment Management.

Funds rarely trumpet such moves, with reason. Money funds aren't bank accounts. They're mutual funds that pool investors' money and buy money market securities, short-term IOUs that mature in a year or less, although many come due in one day. By law, funds must buy only top-rated money market securities; their average dollar-weighted holding must mature in 90 days or less. Funds distribute interest to shareholders, minus expenses.

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