Are Your Money Market Funds Safe?

We often hear from our banks that money market funds are safe and that they rarely, if ever, go down. Well, these funds have been having problems and yesterday a major bank, SunTrust Financial announced it was injecting $1.4 billion into two fund to protect them from losing value.

Much of this loss comes from SIVs. SIVs (Structured Investment Vehicles) are off balance sheet transactions that banks use to boost investetment returns. An SIV transaction involves borrowing short-term money at a low interest rate and then using that money to buy longer-term securities at a higher rate. The f und pockets the difference.

Lately, SIVs have been running into trouble because as liquidity has declined in the market due to the credit crunch,the value of the longer-term securities has fallen. The credit crunch has also made it much more difficult for banks to refinance the short-term debt and as a result, many banks are forced to sell off their longer-term securities at lower prices. Money markets that have engaged in these transactions have suffered losses.

How do you know if your money market fund has invested in SIVs? I called Fidelity and Smith Barney to investigate and received different answers.

Fidelity told me that their money markets don't invest heavily in SIVs and they quoted a figure of 3.6% of the total. I wasn't sure if this was in aggregrate or referring to a specific money market. While the investment specialist tried to be helpful he wasn't very sure of what to say. He said that investors should ask their bank about specific funds.

I then called Smith Barney and was told that this is not a problem with regular money market funds, but only with enhanced money market funds. These are money markets which state they are going to invest in higher risk investments in return for the promise of higher returns. The only problem with this is that I investigated the SunTrust funds that ran into trouble - the STI Classic Institutional Cash Management Money Market Fund and the STI Classic Prime Quality Money Market Fund. Neither of the funds bill themselves as enhanced money markets. The Classic Institutional Cash Management Money Market Fund says the following on its website:

The Fund seeks to provide as high a level of current income as is consistent with the preservation of capital and liquidity by investing in high-quality money market instruments issued by corporations and the U.S. Government.

The Prime Quality Money Market Says:

The Fund seeks to provide as high a level of current income as is consistent with preservation of capital and liquidity by investing exclusively in high-quality money market instruments.

None of this sounds like it shoud be risky. None of it sounds like an enhanced money market.

I do think that if you have substantial money in a money market it warrants a call to your bank, broker, or investment professional. Ask them about SIVs and how much of the fund is invested in these vehicles. At the moment, the banks seem willing to make investors hold by using their own capital to offset losses. If credit conditions continue to deteriorate, who knows if they will continue to do it. A simple call will help you understand your risk and ensure that your safe money is indeed safe.