JP Morgan Chase's Staley Says Money Funds Biggest Systemic Risk

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Head of JP Morgan Chase's investment unit, James Staley, says that money market funds are the biggest risk to the financial system now.  With over $4 trillion parked in money  markets, they are lightly regulated and hold no reserves should something go wrong.

He is quoted in a Bloomberg article as saying:

“What keeps me up at night most of anything we do at JPMorgan Asset Management is the money-market fund space,” Staley said at a discussion hosted today by Credit Suisse Group AG in Davos, Switzerland. “One of the things that has to come out and get a lot more attention and discussion is how do we take the systemic risk posed by money funds out of the system?”

Last September, the collapse of one of the largest money market funds, the Prime Reserve fund led to a run on money markets that was only stopped when the Fed stepped in with guarantees (what hasn't the Fed guaranteed).  

Now, many are reexaming money  market funds to determine just how much of a problem they pose.  Money market funds are comprised of highly rated short term debt as well as cash to meet any redmpetions and ensure liquidity.  They were considered a very safe investment vehicle.

But with a wave of bankruptcies predicted, even high quality, short term corporate debt may be risky.  As we've learned, the ratings agencies have their own agendas and can't be fully trusted.  So even if they rate a bond highly, it is not necessarily safe.  The sudden collapse of Lehman Bros. led to the fall of the Prime Reserve Fund.

The Group of 30, an independent policy organization whose members include Larry Summers and Treasury Secretary Tim Geithner have proposed either forcing money market funds to either adopt banking industry controls (reserve funds, more regulation) or give up their goal of maintaining a $1 NAV.  In essence, accepting regulation and reserves would make money markets into bank deposits, while not accepting would turn them into bond funds.

What does this mean for the average investor?  Be cautious and investigate your money market holding.  If you have free cash from your brokerage account invested in a money market fund you may want to take another look and feel comfortable with what the funds are invested.  Money market fund yields continue to fall, making them a relatively poor investment compared to FDIC money market and savings rates.  And unlike FDIC insured bank accounts, your money markets can lose value.      


Money Market Fund Returns Drop to Record Lows

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Market market fund rates dropped to record lows this week driven by the drop in short term treasury yields.  The top money market fund rate according to BestCashCow is the Vanguard Prime / MMF Investor paying a 7 day trailing yield of 1.64%.  That's down from a top rate of 2.56% in June 2008 and 4.36% in January 2008.

Per Bloomberg:

The average seven-day yield on taxable money-market funds fell below 0.50 percent for the first time in history, to 0.48 percent for the week ending yesterday, according to data compiled by IMoneyNet of Westborough, Massachusetts. Tax-free and municipal money funds remained at an all-time low of 0.29 percent for the second week.

Money market funds, unlike money market accounts are not FDIC insured, although some money may be insured in the wake of the Fed's action to shore up money market funds.  In September of 2008, the Fed announced it was backing money in money market funds that were deposited before September 19, 2008 for a period of one year.

Still, it's hard to get excited about money market funds at these low rates.  Investors may want to consider savings and money market accounts that are paying over 2 percentage points more in interest and are FDIC insured up to $250,000 through December 31, 2009 and $100,000 after that.


Big Banks Hurting But Many; Community Banks Like Brookline Savings Doing Okay

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While the headlines discuss the problems with the nation's biggest banks, many small community banks are doing great. Low borrowing costs and lack of competition from the big boys is helping the community bank grow quickly.

While the headlines discuss the problems with the nation's biggest banks, many small community banks are doing great.  Low borrowing costs and lack of competition from the big boys is helping the community bank grow quickly.

Steven Syre of The Boston Globe discussed this in an article and singled out two banks in Massachusetts, Brookline Savings Bank and Hingham Institution for Savings.  While the article discussed Massachusetts banks there are thousands of small banks across the country that are also benefiting.  As he writes:

"Access to ultracheap money and fading competition from mortgage companies are proving to be powerful advantages for many smaller banks. "Things are going well, particularly in the context of the economy," says Brookline Bancorp's chief executive, Richard Chapman.

Smaller banks are earning an unusually wide spread between the cost of money to them and the rate at which they lend to customers. They can borrow money from the Federal Home Loan Bank of Boston at rates in the range of 2 percent and use it to fund loans earning as much as 4 percent or even 4.5 percent more."

These banks are stable and offer somewhat competitive rates.  Brookline is offering a 12 month CD at 2.40% APY, which is 85 basis points below the top 1 year cd rate on the BestCashCow rate tables.   Still, that's significantly higher than some of the rates of the big banks.  Bank of America was offering a 12 month CD for only 2.10% APY.  So, for many, community banks offer stability with an above average return.

See the best 1-year CD rates here.