G-U-A-R-A-N-T-E-E: Find Out What It Means to Me

Your confidence in the stock market was probably shaken badly in September of 2008. What’s worse, you may have even lost faith in money market funds when a couple “broke the buck” during that same month by falling below a net asset value of $1 (money market funds are supposed to keep a net asset value of $1 with interest as the only gain).

To head off a potential run away from money market funds – depleting their assets and worsening the potential problem – the Treasury Department announced the creation of a guarantee program that would ensure that money market funds kept their $1 net asset value.

Relief quickly spread and, to my knowledge, no further failures have been reported in regard to money market funds and the all-important $1 net asset value. While I understand the logic and am happy with the result, I think I should clear up some misconceptions about this guarantee and what it actually means. Here are a few of the misconceptions around this guarantee:

All of my money within a money market fund is now guaranteed: False. The guarantee only applies to assets within a fund as of September 19, 2008. A great deal of money has shifted since that time to money market funds but NONE of that “new” money is backed by the guarantee.

The guarantee is free because it comes from the government: False. The Treasury Department requires each fund to pay a fee for participation in the guarantee. In many — if not most – cases, the company managing this fund has passed the fee back as an expense of the fund. Yes, you read that correctly, you are probably paying for your own guarantee.

The guarantee is permanent: False. The program is temporary and its initial guarantee period expired in December of 2008 – but has since been extended to April 30, 2009, and potentially may go all the way to September of 2009. Keep in mind that the guarantee still only applies to deposits as of September 19, 2008.

The guarantee ensures that all of my money in money market funds is immediately available: False. The guarantee doesn’t mean that you’ll receive an immediate payment if your fund breaks the buck. Per the Treasury Department, “…a guarantee payment should be made to investors through their fund within approximately 30 days, subject to possible extensions at the discretion of the Treasury.” In English: you’ll get the guaranteed portion of your money when they decide to give it to you.

Yes. There is much to misunderstand regarding this guarantee. The obvious limitations aside; there is a significant positive side to this program: funds that wished to participate in the program had to tell the Treasury Department just how far away from a $1 they were (the further away, the higher the fee to participate). One can only imagine how uncomfortable this “turn and cough” procedure was for funds that were significantly below $1 but still clinging to life.

I remain fuzzy on what will become of the participation fees. Treasury estimated that over $3 trillion is invested in money market funds as of the inception of the guarantee which, if true, created over $300 million in fees for the initial period. The extension to April and any further extensions will generate even larger fees (rates have gone up). If no further money market failures occur, this sizeable pot of money (primarily paid for by investors) will presumably reside under the control of the Treasury Department until further notice. I, for one, will be asking some questions in late 2009 regarding the final resting place of these assets…

For now, investors should ask the same tough questions before making a new investment in a money market fund that they would typically ask before buying a bond fund (management tenure, net cash flow, expenses, average maturity, duration and credit quality). If you find that the manager doesn’t wish to share these details, keep looking for someone that will.

At the end of the day we still have this rather limited guarantee for any assets that we placed in a money market fund prior to September 19, 2008. So we’ve got that going for us — which is nice.

*Originally published January, 2009.