When you open a regular brokerage account and leave money uninvested, something happens that most account holders never look closely at. The money is immediately and silently scooped into a brokerage-affiliated bank deposit scheme. The validation appears as a tiny yield figure somewhere in the account data. Your money appears to be working. It appears to be liquid, safe, and profitable. It doesn’t display, in the same conspicuous spot, what the brokerage is making on the same cash, which is usually much more, or how much the yield difference between those two numbers is costing you over the course of a year, ten years, or your working life.
It seems sense that the financial services sector has been reluctant to highlight the underlying mismatch that underlies the liquidity trap cash investment on which America has based its cash parking habits. In sweep programs, retail investors that keep cash often receive a small portion of the current federal funds rate. A brokerage sweep account may pay 0.35% or less while the Fed funds rate is at 4.5%.
In the meantime, the brokerage uses that same money to invest in securities with significantly higher yields, such as short-term credit, overnight lending markets, and treasury holdings, and it records the difference as margin. The feature being promoted is that the ordinary investor has instant access to their money. The entire potential return on their capital is what they are sacrificing in return.
This issue seems to be resolved by money market funds, and they have done so for the majority of the last 20 years. MMFs pass through yields that are significantly closer to current market rates than sweep accounts usually offer since they invest in short-term, high-quality securities like Treasury bills and commercial paper. However, the various mechanisms that drive the liquidity trap within MMFs are most apparent when interest rates decline.
Management fees, administrative expenditures, and operating expenses that were undetectable while yields were 4% become impossible to conceal when yields are 0.2% in a low-interest-rate environment, such as the one that lasted from 2009 to 2021 and may recur if the Fed dramatically eases. In severe circumstances, as the post-2008 period actually showed, the net yield compresses, and some funds actually found it difficult to sustain a positive return after fees. There were significant differences between the yield investors perceived on paper and the return they were really accumulating.
When people first come across the redemption gate provision, it elicits the strongest visceral response. During times of severe market stress, fund managers may impose withdrawal halts of up to ten business days under the SEC’s laws governing money market funds, especially institutional funds and non-government retail funds. Under the same conditions, they may also impose liquidity costs of up to 2% on redemptions. The reasoning is sound: unfettered withdrawals might worsen the situation and hurt surviving investors during an MMF run.
However, the practical implication for someone who put money in an MMF because they needed it to be accessible—for example, to cover an unforeseen expense, meet a margin call, or act quickly on an investment opportunity—is that the instrument they treated as a cash equivalent may, in the worst case scenario, behave like something significantly less liquid.
This has no theoretical historical antecedent. The Reserve Primary Fund’s problems during the 2008 financial crisis caused a wider panic in the money market sector, which resulted in a federal guarantee program that stopped a more widespread run.
The gate and charge clauses were a component of the post-2008 regulatory reforms, which were intended to lessen the possibility of repetition but acknowledged that the risk had not been completely eradicated but had simply been handled differently. The provisions might not be used very often or at all. It’s also likely that the circumstances in which they become important are the same ones in which having access to money is most important.
