New proposal may give money market accounts an edge
February 15, 2012
A new proposal by the Securities and Exchange Commission (SEC) regarding money market funds makes bank money market accounts look more attractive by contrast -- and underscores the importance of the distinction between money market funds and money market accounts.
Though the similarity of their names makes it easy to confuse money market funds and money market accounts, they have a fundamental difference. The similarity comes from the fact that both generate interest through investment in the money markets, which consist of short-term, income-generating instruments. However, money market funds do this by acting as a mutual fund, with the value of the fund riding on a specific set of investments. Money market accounts are general obligations of banks, and in turn are backed by FDIC insurance.
If the SEC proposal moves forward, this difference will be more important than ever.
The SEC proposal
In 2008, the financial crisis jeopardized the value of some money market funds, triggering a run on those funds that exacerbated the problem. Money market funds have traditionally been held at a stable value of $1 per share, and when the value of some funds threaten to fall below that mark, the federal government stepped in with temporary guarantees to stabilize the markets.
To avoid a repeat of this situation, the SEC now proposes that the price of money market funds be required to fluctuate according to the value of the underlying securities. This would make changes in value clear on a continuous basis, so that the funds would be less subject to sudden shocks if they could no longer maintain a $1 per share value. The SEC would also limit investors to redeeming 95 percent of their holdings at any one time, with the remaining 5 percent not available for another 30 days.
The reality of money market funds
Though money market funds have lost some popularity since 2008, they still represent a $2.7 trillion business. They are widely used by institutional investors as a predictable and liquid source of capital for trading purposes. The proposals to let their values fluctuate and to limit liquidity would significantly reduce the usefulness of money market funds in this capacity.
The reality, though, is that something has to give. Money market funds have tried to do too much in the past -- providing stable values and liquidity while investing aggressively enough to earn returns strong enough to justify fund company fees. This has led to some risky investments that are not consistent with stability and liquidity.
The value of money market accounts
As the mutual fund industry argues bitterly against the SEC's proposal, bank customers should be comfortable in the knowledge that money market accounts are not affected by it. While not suitable as frequent trading vehicles like their fund counterparts, money market accounts remain a source of ready liquidity and stable values. Now if only their interest rates would rise ...
