The threat to your money market fund

No investor wants to show a loss on the books, but this is an especially big problem for money market funds. Securities and Exchange Commission rules allow money market funds to use constant share prices -- the $1-a-share gold standard -- as long as they also calculate a price that reflects the portfolio's value at current market prices.

As long as the actual price doesn't fall below the SEC's threshold of 99.9 cents, the fund can use the constant $1 share price. If the market price of the portfolio falls below that level, the fund has to use the actual price and "break the buck." Breaking the buck can be tremendously expensive for a money market fund. It panics investors into pulling money out of the fund, forcing the fund manager to sell more assets at depressed prices. That drives the fund price lower and increases redemptions.

The damage to a fund's market position is so large that in the few cases where a fund has threatened to break the buck, the management company has stepped in to bail out the money market fund and maintain the $1-a-share value. For example, in 1989, a fund management company took a $32 million loss to maintain the $1-a-share market at two of its money market funds after the default of Integrated Resources, a major issuer of commercial paper.

No fund manager who values his or her career wants to risk creating that kind of loss.

The end is not near

With money market funds and other buyers sitting on the sidelines, the amount of outstanding commercial paper in U.S. markets dropped for three straight weeks in August, falling by about 11%. The biggest drop came, according to the Federal Reserve, in the market for asset-backed commercial paper. In the four weeks that ended Sept. 8, that market shrank by $216 billion, or 18%.

For holders of money market funds, this sitting on the sidelines means falling yields at the funds they own. Instead of putting money into asset-backed commercial paper, funds will buy traditional commercial paper or ultrasafe but lower-yielding Treasury bills. Less interest income coming in means less interest paid out. The average yield on a taxable money market fund dropped to 4.5% at the end of August from 4.8% at the beginning of the month before rebounding to 4.7% in early September. I expect yields to continue to creep lower as long as money market funds' managers remain leery of the commercial-paper market and the asset-backed sector in particular.

For some borrowers, a shrinking market for commercial paper is a potential disaster. Some companies, those such as General Electric (GE, news, msgs), that borrowed in this market on their corporate credit ratings will have no trouble raising funds. Those reliant on the asset-backed commercial-paper market won't be able to roll over their paper when it matures -- and about $1 trillion in commercial paper will mature in the next few months.

These companies will have to look to bank loans to get through the crisis -- if they get through it at all. Getting those loans won't be easy because banks don't have any more desire to see debt backed by tarnished assets with unknown value on their books than money market funds' managers do. (Banks still need capital, though, and they'll try to get it from depositors -- one reason why I think yields are headed up on certificates of deposit.)

Ending the buyers strike by money market funds' managers and other investors in commercial paper won't be easy. It can't be ended by flooding the market with liquidity or cutting interest rates. It will end only when buyers believe they can trust prices on debt backed by subprime mortgages, buyout loans and credit derivatives. That's tough when, because of the buyers strike, some assets aren't trading at all.

Working this one out is going to take a while.

New developments on past stories

"Can tech stocks spark a 2007 rally?": The ramp-up in production of Motorola's (MOT, news, msgs) new wireless chip set has finally started. Delays in production at Motorola have clobbered shares of SiRF Technology Holdings (SIRF, news, msgs), where Motorola is one of the biggest customers. Earlier in the year, SiRF had told Wall Street to expect sales to a "big customer," generally thought to be Motorola, to kick in no earlier than the third quarter, a big shift from previous projections that showed sales from that source materializing in the first three months of the year.

Add news of a significant win in the European market for GSM-based wireless phones, and I think investors who stuck with this stock through the hard times in the first half of 2007 will be rewarded in the year's last quarter. As of Sept. 14, I'm keeping my target price at $34.50 a share by December 2007. (Full disclosure: I own shares of SiRF in my personal portfolio.)

Editor's note: A new Jubak's Journal is posted every Tuesday and Friday. Please note that recommendations in Jubak's Picksare for a 12- to 18-month time horizon. For suggestions to help navigate the treacherous interest rate environment, see Jim Jubak's portfolio of Dividend stocks for income investors. For picks with a truly long-term perspective, see Jubak's 50 best stocks in the worldor Future Fantastic 50 Portfolio. E-mail Jim Jubak at jjmail@microsoft.com.

At the time of publication, Jim Jubak owned or controlled shares of the following equity mentioned in this column: SiRF Technology Holdings. He did not own short positions in any stock mentioned in this column.

< previous |  1 | 2 |