John Edward, a resident of Chelmsford who earned his master’s degree at UMass Lowell and who teaches economics at Bentley University and UMass Lowell, contributes the following column.
Investing is not for the faint of heart. Danger lurks in these unstable times. Thankfully, money market funds offer a risk-free place to protect your money.
During the financial crisis, the “shadow banking system” gained notoriety. People on Main Street heard more than they ever wanted to about obscure Wall Street contraptions such as collateralized debt obligations and credit default swaps.
The money market is part of the shadow banking system. Money market funds need to come out of the dark shadows. They may not be as safe as you think. There are steps you can take for your own safety – more on that later.
A money market is just what it sounds like. It is a place to borrow or lend money.
Businesses, and governments, often need to borrow money for just a few days or weeks. For example, a company needs to cut paychecks before customers pay bills. Going to a bank requires too much overhead and the interest rate might be too high. Instead, they borrow in a money market.
The money market is for exchanging IOUs. The Securities and Exchange Commission (SEC) requires that IOUs in money market funds have a high credit rating. Any IOUs they invest in must have a short length of time before payment is due. At the end of July the average maturity for money market fund IOUs was 45 days. Money markets are considered safe due to the high credit rating and short duration of the loans.
There is plenty of evidence that savers consider money market mutual funds to be perfectly safe. The evidence is the 2.5 trillion dollars deposited in these funds. That is a lot of money tied up in an investment with an average return of 0.03 percent. With inflation, shareholders are effectively paying more than two percent to park their money in what they think of as a safe place.
If you have money in a money market account, you are lending money. Lending is risky. Borrowers do not always pay up. The financial crisis started with homeowners failing to make mortgage payments. Many of the securities based on mortgage IOUs also had a high credit rating.
Like other mutual funds, money market funds have a share price. With stock and bond funds, the share price reflects the value of the underlying securities. Those values, and therefore the share prices, can be quite volatile. read more »