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Money market funds moving way too fast

Reuters

Fast cars and fast money can go to the heads of traders. U.S. money market funds are a vehicle for pretty cautious investors, but the managers have a dizzying $2.5-trillion (U.S.) to play with. The Federal Reserve is raising concerns that they're driving way too fast.

French bankers can be forgiven for feeling run over. In August, JPMorgan calculates funds withdrew $39-billion from French banks, which are perceived as vulnerable in the euro zone sovereign debt crisis. There is an irony here. The funds' goal is to prevent losses, but such sudden shifts make the financial system less stable.

There's another irony. Money market funds are prized by investors in part because they are supposed to have less counterparty risk than banks. Yet, roughly three-quarters of the $1.5-trillion managed by prime money market funds (the non-government part of the market) is estimated to be invested in bank debt.

These funds have basically been on the run for years. Low short-term rates make profits elusive and customers have deserted the funds - assets are down nearly 30 per cent since the 2009 peak. Money has moved into more traditional bank deposits, and will continue to do so as long as short-term yields stay low - the Federal Reserve has pledged at least two years.

Also, while safety is the funds' watchword, it has been hard to find. Money markets bailed out of U.S. financial institutions after Lehman proved that investment banks can indeed fail. European banks looked safer - until Greece struck and investors ran again.

Still, the decline of money market funds could be a good thing for a financial system that suffers from hazardous volatility. Cooler money may lead to cooler heads.

© 2007 The Globe and Mail. All rights reserved.

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