SYLVIE DOUGLIS, BYLINE: NPR.
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ADRIAN MA, HOST:
This is THE INDICATOR FROM PLANET MONEY. I'm Adrian Ma.
WAILIN WONG, HOST:
And I'm Wailin Wong. Back in March, U.S. Treasury Secretary Janet Yellen won a lifetime achievement award from a group of economists. In her acceptance speech, she talked about the stability of the financial system. This is a pretty hot topic, given that Silicon Valley Bank and Signature Bank had collapsed earlier that month.
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JANET YELLEN: And if there's any place where the vulnerabilities of the system to runs and fire sales have been clear cut...
MA: What's she going to say? Regional banks?
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YELLEN: ...It is money market funds.
WONG: Oh, Janet Yellen - she stumped you, Adrian. Money market funds. They are not banks, but they do hold a lot of money - $5.75 trillion in assets. Money market funds are a huge piece of the financial system that, like Janet Yellen warned, have some vulnerabilities.
MA: Yeah. And, you know, between a recent string of failed banks and also a possible U.S. debt default, there is a reason to worry about the stability of money market funds. So today on the show, we explain how these funds work, where the dangers are and how the government wants to try and make them safer.
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MA: OK, Wailin, so a couple of weeks ago, as you know, I was talking to a friend about personal finance stuff. He was saying, like, you just can't really get any interest rate on a regular savings account anymore, right? They're so low. But then he told me that he had started putting his money in this thing called a money market fund. And I was like, great, what's a money market fund? And he's like, I don't actually know.
WONG: (Laughter).
MA: And I was like, what?
WONG: Well, this episode goes out to your friend and anyone else who keeps hearing about these things but doesn't know how they work. Maybe you have your money in one of these things, and you still don't know how they work. So a money market fund is a type of investment called a mutual fund.
MA: Right. A mutual fund is where a bunch of people or institutions pool money together, and a professional fund manager puts that money to work.
WONG: Now, there are all kinds of mutual funds out there, like ones that invest in stocks or a mix of stocks and bonds. You can buy shares of a mutual fund through an online brokerage.
MA: Yeah. And what makes money market funds stand out in this whole sea of mutual funds is this really alluring combination of three things. First, they are considered super safe. Second, they pay out a higher return than what you might get from a regular bank account. And third, they are very liquid, which means you can get your money out pretty quickly.
WONG: Regular people use money market funds as close substitutes for traditional bank accounts. And so do business owners and executives who are managing cash for companies.
MA: Kenechukwu Anadu studies financial stability at the Federal Reserve Bank of Boston. And he wanted us to mention that he's not speaking on behalf of the bank but just from his own expertise as a researcher. And he says money market funds were created to give investors better returns than they could get on bank accounts.
KENECHUKWU ANADU: Back in the '70s, there was a Federal Reserve regulation that capped the interest rates that banks could pay.
WONG: So in the early '70s, there were two finance guys who were like, what if people could chip in and invest all together in something that paid out more than what banks are offering?
ANADU: This included, you know, not just individual investors but also small businesses that were looking for higher yield than cash options.
WONG: These two guys came up with the first money market fund. Fifty-plus years and several trillion dollars later, this industry has grown into a huge piece of financial infrastructure.
MA: And in the last year or so, the Fed has hiked interest rates. But traditional banks are still offering pretty low rates on savings accounts. So investors have moved billions of dollars out of those bank accounts and into money market funds because, remember, these funds are a safe and liquid way to earn higher returns.
WONG: So here is how money market funds are structured today. They invest in debt like U.S. Treasurys, corporate bonds and municipal bonds, you know, the debt that governments and companies sell in order to raise money for their everyday operations.
MA: These bonds are also short term, meaning they typically come due in a matter of months instead of years. And they generally have low risk of default. So they're considered safe and boring, therefore making money market funds safe and boring.
WONG: And the stability of these funds is reflected in how they're priced. So if you want to invest in a money market fund, you do that by buying shares, kind of like how if you want to invest in a stock, you buy shares of that company. But unlike a stock price that bounces around, the price for a money market fund is basically $1 per share.
ANADU: So that means that if I invest $1 into a fund, I can expect to receive one share in the fund. And conversely, if I sell my one share, I expect to receive $1.
MA: Now, if that level falls below a dollar, it is a sign that something has gone really wrong. And there's a name for this, called breaking the buck.
ANADU: In September of 2008, a large fund broke the buck due to its holdings of Lehman Brothers debt. Of course, Lehman Brothers failed.
WONG: So it had all this Lehman Brothers debt. That debt basically just became worthless, right?
ANADU: That's correct. Now, following this event, investors, you know, likely concerned about losses, redeemed large amounts from their funds.
MA: Redeemed, meaning they withdrew their money. This was a classic run, not on a bank but on money market funds holding corporate debt. People who were invested in these funds took their money and stampeded towards the exits.
WONG: When money market funds have to cash out a lot of investors all at once, they can have trouble turning their assets into cash quickly enough. They might have to sell their holdings at a deep discount. When that happens, they've gone from a run to a fire sale.
MA: And that is the kind of scenario Janet Yellen was talking about in her speech. It's why the Fed specifically mentioned money market funds in a recent report about financial stability. That report said that during periods of financial stress, there's a risk investors will withdraw their money en masse.
WONG: Now, historically, when people in the markets get skittish, they move their money into U.S. government bonds, you know, because U.S. Treasurys are some of the safest, most boring investments out there.
MA: But lately, as we've covered on THE INDICATOR, the Treasury markets have been a little turbulent, a little on edge, especially as the days tick by without a deal on the debt ceiling, and the government gets closer to the X date when it can't pay its bills anymore.
WONG: Hung Tran is an economist at the Atlantic Council think tank. He says right now people are leery of buying US Treasurys that come due in early June. That's the estimate for when the X date is supposed to hit, and the government could be in default.
HUNG TRAN: The U.S. government might be put in technical default situation. Now, because of that, people try to avoid buying or holding Treasury bills maturing right after the X date.
MA: In other words, the debt ceiling problem is dampening demand for short-term Treasury bonds, which are a huge chunk of money market fund portfolios. So those portfolios could take a hit, which could make investors nervous. And if a lot of them get spooked enough to withdraw their money, that could destabilize money market funds and the broader financial system.
WONG: Now, things have changed since 2008, when Lehman collapsed and that one big money market fund broke the buck. Regulators put in safeguards. Certain funds were allowed to temporarily suspend withdrawals or charge investors a fee for taking their money out. This would happen in times of market stress. And Hung says so far, money market funds haven't needed to resort to these measures.
TRAN: Let's hope that they won't need to be used.
MA: Some policymakers, including Janet Yellen, say more can be done to make money market funds safer. One critique of the current safeguards is that they might actually encourage people to be first out the door because they want to exit before things get really bad, like, before the money market fund breaks the buck.
WONG: Right - because if you invested at a dollar per share, you want to cash out at a dollar a share, not 95 cents a share.
MA: Exactly. So regulators are considering another round of changes, including a mechanism that would impose some costs on those early exiters. You know, make them think twice about whether they really want to leave.
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WONG: This episode was produced by Corey Bridges, with engineering from Katherine Silva. Sierra Juarez checked the facts. Viet Le is our senior producer. Kate Concannon edits the show. And THE INDICATOR is a production of NPR.
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