Breaking the Buck: A Main Street Solution to a Wall Street Problem

June 22, 2016

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The first money market mutual fund, The Reserve Fund, was established in the U. S. in 1971. These funds were set up to allow investors to earn a small rate of return while keeping their money safe and liquid. They were designed as an alternative to bank accounts. At that time Regulation Q prevented banks from paying interest on demand accounts and capped the rate of interest that could be paid on other deposits.

The idea was that the funds would invest only in short-term, high quality securities such as U. S. Government securities and high-grade commercial paper. They would have a net asset value (NAV) of exactly $1.00 per share at all times. For the most part, money market mutual funds have been stable and safe investments since they were first formulated, with just a few exceptions.

Many investors think of them as being as safe as bank deposits, but the reality is a little more complex. It will soon become even more complicated with new rule changes by the Securities and Exchange Commission (SEC) that will become effective in October 2016. Some money market mutual funds will no longer be able to claim a stable NAV of $1.00 per share, and will be subject to changes in market value.

The way that money market mutual funds have been able to maintain a stable NAV of $1.00 is quite interesting. The SEC has allowed these funds to account for their value using a historical cost method rather than marking them to the market value of the underlying securities. Funds are tested weekly to determine if their “shadow-priced NAV” (an estimate of market value) is within $.005 of the stated NAV of $1.00. If not, the fund is considered to have “broken the buck” and its investors can suffer a loss. Although this has rarely happened, maintaining this tight range in the NAV can be a problem for funds in the midst of market turmoil and financial crisis.

The most recent and well-known example of breaking the buck occurred in 2008 when the very first money market mutual fund, the Reserve Primary Fund, had to write off the value of securities that had been issued by Lehman Brothers. This loss brought the NAV of their shares down to $0.97 and triggered a panicked run on other funds that threatened their stability as well. Companies that operated many of these funds had to bail them out with outside money to defend their value. The panic was not stemmed until the U. S. Treasury announced a program to temporarily guarantee money market fund investments.

The new SEC rule (coming a mere eight years after the Reserve Primary Fund meltdown) recognizes that the accounting rules for certain money market mutual funds need to be changed to reflect their actual risk. Prime money funds, which are money market funds which invest in non-government securities such as commercial paper, will have a floating NAV rounded to four decimal places. This change will have a profound effect on institutional and governmental money managers whose investment policies and state laws may not allow them to invest money in a vehicle subject to explicit market risk.

The $1.00 NAV is still in place for Retail funds (funds available only to “natural persons”) and for Government funds (funds that invest only in government securities). But the SEC is imposing new redemption fees and limitations on Retail and Prime funds that are designed to discourage panic withdrawals such as the ones that occurred in 2008. This seems to me that it will limit liquidity during a systemic financial crisis when, panicked or not, you may need your money sooner rather than later.

There is a Main Street solution to this Wall Street problem that achieves the goals of safety, liquidity, and earnings that the original money market funds were intended to address. Insured Cash Sweep (ICS) accounts allow for investors to maintain FDIC insurance on multi-million dollar balances, while maintaining access to funds and earning a competitive return. Funds are distributed throughout a network of participating banks, each institution holding a portion of the balance under the deposit insurance limit of $250,000 per depositor. The investor/depositor deals with just one relationship bank that automates this process. The customer receives one consolidated statement of account, and knows in real time where their money is.

With an ICS account there are never any NAV worries, since all funds are in dollar denominated bank deposits. The only limit to access is the limitation of six withdrawals per month, the same as for any bank savings or money market deposit account. Even if this limit were to be met, an account could still be closed and the money withdrawn, or it could be converted to a demand account with no withdrawal limits.

The biggest comfort of all is that with FDIC insurance protection, ICS deposits are backed by the full faith and credit of the United States, still be highest form of security available in the world.

Business Bank of Texas is a member of the Promontory Interfinancial Network, the network of banks that supports the Insured Cash Sweep program. We have been successful in providing insured deposit solutions for both government and commercial entities. The quest for safety, liquidity, and earnings has now turned full circle, with ICS deposits providing a solution to the new mutual fund problem.

If you are interested in keeping your bucks unbroken with ICS, download our fact sheet or reach out to Ivonne Villegas to find out more.  

Download our fact sheet  to learn more about Insured Cash Sweeps

Topics: Bank Products

Dwayne Kolly

Business Bank of Texas

Dwayne Kolly brings a wealth of financial management and operations experience to Business Bank of Texas. Kolly has served community banks in south and central Texas for nearly 30 years, and is the bank’s CEO and Chief Financial Officer. He is a graduate of the Southwestern Graduate School of Banking at SMU (1993).
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