The majority of government money market fund owners have never read the prospectus. It’s an observation about how these reports are offered and perceived, not a critique. They are located in retirement accounts and brokerage platforms that are touted as cash equivalents. They are the financial equivalent of a well-organized drawer, where you store money while you decide what to do with it. The yield is not very high. Everyone agrees that there is virtually no risk. It is supported by the US government. What might go wrong? Contrary to what most fund marketing materials imply, the truthful response to that query is more detailed and frightening.
The type of risk that is neglected in government money market funds is different from that that arises in regular market circumstances. It is the type that emerges during debt ceiling standoffs, which are becoming more common when the White House and Congress cannot agree on the federal borrowing cap, forcing the Treasury Department to the brink of a technical default. Short-term Treasury bills, which are often the safest asset in the financial system, make up a large portion of government money market funds.
However, the value of the particular T-bills maturing around that timeframe may decrease as the debt ceiling deadline draws near and the market begins pricing in even a tiny chance that the government would momentarily miss a scheduled payment. The amount that should remain constant at $1.00 per share, the fund’s Net Asset Value, fluctuates along with it. In absolute terms, that movement is negligible. When it occurs, there is no psychological impact.
People on fixed incomes still bring up the Reserve Primary Fund meltdown of 2008 while discussing this subject. After holding Lehman Brothers commercial paper that lost all of its value overnight, the fund “broke the buck”—its NAV dropped below $1.00. That one fund wasn’t the only source of the ensuing hysteria. Within hours, it expanded throughout the money market sector, causing redemption runs that needed to be stopped by a federal guarantee scheme.
People point to government funds as the safer option because Reserve Primary was not a government fund. However, the lesson that is commonly overlooked in that story is how easily a structure that everyone believed to be impenetrable can turn become the focal point of a crisis when the correct set of conditions emerges.
A complexity that most fund holders never consider is added by the buyback agreement layer. To handle their daily liquidity needs, government funds frequently park cash in overnight repo transactions, which are effectively short-term loans secured by government securities. The fund’s exposure to counterparty risk becomes actual rather than hypothetical when the institutions involved in those transactions experience their own stress. Although the collateral is usually of excellent quality, investors attempting to withdraw money during a crisis lack the time necessary to wind down repo positions during a liquidity shortage.
The gating provision is the regulatory mechanism that most surprises people. Government money market funds are currently permitted under SEC regulations to apply interim liquidity fees or complete withdrawal restrictions during times of severe market stress, but they are not required to do so. The fund documentation contains the legal wording.
The worst time to find out that the account you treat as a checking account may, under certain circumstances, advise you to wait is when it becomes relevant, which is when almost no one reads it. Although no government fund has yet to employ this provision, it is feasible that it will never be used. However, the authorization is in place, and the circumstances under which it might be used are not impossible.
Another issue is how various fund managers approach the same type of risk. The notion that all government money market funds are fundamentally the same is a fallacy that needs closer examination than it now receives. Two funds with the same label may have significantly different risk profiles during a stress event due to manager discretion over when to shorten maturities during an impending crisis, which counterparties to utilize for repo, and how aggressively to position for liquidity.
Legal clarity is provided by the category name. It doesn’t offer consistency in implementation. It’s difficult to ignore how infrequently consumers discuss that distinction with their financial counselors when choosing where to save funds. There’s a sense that, in one way or another, the next major confrontation will eventually close the gap between how these instruments are perceived and how they actually perform under duress after watching this develop over multiple debt ceiling cycles.
