Recent bank failures prompted outflows of U.S. bank deposits into systemically important banks, but money market funds — less used by treasurers and CFOs the past few years — also benefited.
About $30.3 billion was poured into U.S. money-market funds (MMFs) in the week of April 12, according to data from the Investment Company Institute.
Less risky government funds — which invest in securities such as Treasury bills and government agency debt — saw assets rise to $4.4 trillion, a $26.8 billion increase. The rest went to so-called “prime funds,” which invest in higher-risk assets such as commercial paper.
Many institutions ... choose to leave large sums of uninvested cash in their operating accounts as a habit of convenience and unwittingly expose their organizations to an unnecessary source of credit risk. — Lance Pan, Capital Advisors Group
U.S. MMFs now have total net assets of $5.3 trillion, nearly equal to the combined deposits of the top three U.S. banks (as of the end of 2022).
The surge in money market fund assets was partly due to the shutdown of Silicon Valley Bank (SVB) in early March by regulators. The SVB situation, which required the federal government to guarantee all customer deposits, alerted businesses to the risk of having large amounts of cash in accounts that exceeded the $250,000-per-customer FDIC insurance limit.
“For businesses with large, unpredictable daily cash flows, keeping a large balance is an unavoidable and accepted risk,” wrote Lance Pan, director of research and investment strategy at Capital Advisors Group, in a March 29 commentary. “Many institutions, however, choose to leave large sums of uninvested cash in their operating accounts as a habit of convenience and unwittingly expose their organizations to an unnecessary source of credit risk.”
But is investing a portion of a company’s excess cash into money market funds a sound decision?
When comparing the risk of investing in MMFs versus storing cash in uninsured bank deposits, the point is moot “if the [federal] government decides to guarantee all deposits, as it did in limited cases in March,” Chief Economist Sean Collins of ICI, told CFO. But, he added, “money funds of whatever type are extremely low risk because by regulation they must hold high quality, short-term, and very liquid assets.”
CFOs Stay Conservative
Since the 2008 financial crisis, CFOs and treasurers have stayed away from prime MMFs, due to the problems that occurred. During the crisis, anticipated losses on Lehman Brothers commercial paper led to a run (investor redemptions of their shares) on the $62 billion Reserve Primary Fund, the oldest MMFs. Fear spread across the market and affected other funds.
The market also saw some stress in March 2020, when prime funds held by institutional investors experienced net redemptions of about 30% of their total assets in two weeks, according to a Government Accountability report.
Like the rescues of SVB and Signature Bank last quarter, when prime MMFs ran into trouble in 2008 and 2020, the federal government backstopped the funds and kept markets functioning smoothly.
Even though federal regulators have bailed out prime funds twice, companies with excess cash have mostly stuck with government funds. The latest Association for Financial Professionals Liquidity Survey, in June 2022, found very few surveyed companies had any cash in prime funds. Government and Treasury MMFs made up 14% of organizations’ cash allocations.
The banks got the lion's share of excess cash, though — the typical organization maintained 55% of its short-term investments in bank deposits, the highest figure since 2016.
Part of the reason money is flowing into MMFs now — not just from some businesses but also institutional investors — is due to higher returns than bank deposits. The Fidelity Government Money Market Fund has a seven-day yield of 4.48% as of April 14.
Risk and Liquidity Comparisons
To decide whether to invest in MMFs, businesses need to “understand their level of risk versus return on cash as well as their liquidity needs,” according to Paul M. Galloway, a senior director of advisory services at Strategic Treasurer, a corporate treasury consulting firm.
Said Collins: "The problems with some banks will encourage some large depositors to review counterparty risks."
With uninsured bank deposits, “what people may not always consider is that banks are in the business of managed risk,” said Galloway, earning returns mainly through lending. While banks have to keep reserves on hand to meet depositor calls for cash, they can get in trouble if they make risky loans, especially in a rising interest-rate environment.
“As a depositor at a bank, you don’t know the creditworthiness of all the borrowers the bank lends to; you are trusting that the bank will act in your best interests and take appropriate steps to protect your deposits,” Galloway said.
In today’s market, many government money market funds have a one-day liquidity of nearly two-thirds of the total portfolio. — Paul M. Galloway, Strategic Treasurer
Government MMFs, in contrast, invest in Treasury and government debt backed by or having the implied backing of the U.S. government. “The U.S. government as a borrower is something most people can relate to as a counterparty with high credit,” Galloway said.
As far as liquidity, nothing can match the liquidity of a checking account, but government market funds tend to be pretty liquid. Under the Securities and Exchange Commission’s 2a-7 rule, they must hold 30% of their portfolio in cash convertible assets over five days. The weighted average maturity of investments can be no longer than 60 days.
“In today’s market, many government money market funds have a one-day liquidity of nearly two-thirds of the total portfolio,” said Galloway. “This allows the portfolio managers to manage calls on cash.”
With the recent movement of deposits from banks to government money markets, “many portfolio managers have maintained a higher level of liquidity as the inflow of funds is seen as less sticky over time,” Galloway added.
During this quarter, the Securities and Exchange Commission is set to complete a rulemaking designed to make MMFs even more liquid and less subject to market stress and panicky redemptions by investors. It will be the third round of regulatory reforms for money market funds since the financial crisis.