-- The government's emergency plan to stop a run on money market funds stands to stem the panic for now, but raises serious questions that will change the way investors handle their savings.
Friday the Federal Reserve and Treasury announced separate but complementary moves to shore up what was turning into a exodus from the $3.4 trillion pool of money market funds.
The Fed said it would lend money to banks, which would in turn buy securities from money market funds to provide them with the cash they may need to pay out to investors who want to redeem. Worries over the safety of money market funds led investors to pull out $49.3 billion on Thursday and $90 billion on Wednesday, says Peter Crane of Crane Data.
Meanwhile, the Treasury said it was tapping up to $50 billion to insure the holdings of any public money market mutual fund that chooses to participate in the plan. The insurance program is expected to last a year.
The historic moves by the government likely will quell panic hitting money funds, but also will dramatically change the way investors perceive the risk connected to certain savings vehicles. They also may change fees, yields and the competition between banks and money market fund providers.
"This is a game changer," says Michael Holland of Holland & Co.
Major issues surrounding the move include:
•The limits of the protection and who is eligible. Unlike the Federal Deposit Insurance Corp., which guarantees bank deposits up to $100,000 per depositor, the Treasury says its plan has no set limit at this point.
Since the plan covers money funds owned by both individual and large institutional investors, which implies the limit will be larger than $100,000, Crane says. Many institutional money funds have minimum deposits of $1 million and are used by giant companies and pensions. "$100,000 (in protection) isn't going to do much for IBM," he says.
•The cost. The Treasury's plan is voluntary and there will be a fee charged to funds that participate. Fees will likely be passed along to investors in the form of lower yields, says Brian Sack of Macroeconomic Advisors.
The fee structure is yet to be set, says Jennifer Zuccarelli, Treasury spokeswoman. But Crane says with money funds only yielding 2.3% and the Federal Funds rate at 2%, the fee can only be so much before the funds aren't competitive. Crane estimates the fee would be 0.5% or much less. Bill Larkin, of Cabot Money Management, guesses 0.1% or less.
"We don't know the cost," says Deborah Cunningham, chief investment officer at Federated Investors. "The government is not going to lose money on this."
•Government's role in how the funds are managed going forward. Cunningham says the government will not likely tighten rules on how money funds are operated because it will view current regulations "as strict enough," she says. But Crane says the government will want to hold the industry accountable. "Dad's going to be taking the keys away for awhile," he says.
•Who will sign up for the insurance. So far, most money fund providers have adamantly stated their funds don't own the loans that have caused problems for The Reserve Primary Fund, which stunned investors last week when its value dropped below $1 a share due to investments in Lehman securities. But given how nervous investors are, funds will likely need the insurance to remain competitive, Crane says. "There's not a money fund alive that's not lined up to buy the insurance," he says.
Vanguard, Federated and Fidelity all say they are reviewing the plan.
•Competition with banks. Consumers have long been willing to take lower yields from banks, knowing they were safer than money markets. But the government's plan disrupts this balance since investors will now assume they'll ultimately get bailed out, says Edward Yingling, CEO of the American Bankers Association. "This is the most massive extension of a safety net we've ever seen" he says.
Larkin, though, doubts this, saying investors in money funds have gotten a refresher course on the difference between money funds and bank deposits and will pick accordingly. "There are bank people and other types always looking for what's my best opportunity," he says. "But everyone can sleep at night now."