The Debt Ceiling's New Threat to Your Money

Money market mutual funds are supposed to be a safe place for investors to stash their cash and earn a reasonable return. Yet for years, money markets haven't given their investors much income, and now the debt-ceiling crisis is raising new fears about the potential stability of the funds.

Fidelity Investments, which is a major manager of money market mutual funds, has gradually been selling off its holdings of U.S. government debt in recent weeks. The Associated Press reported that Fidelity has succeeded in divesting itself entirely of any Treasury debt maturing in late October or early November. Although Fidelity has been careful to say that it still expects Congress to raise the debt ceiling and avoid a default on Treasuries, it nevertheless sees the "precautionary measures" as necessary to protect shareholders.

A run on money market funds?
Fidelity's move underscores a big threat that money market funds could face in a default situation. Most investors treat their money market funds much like bank accounts, with many funds offering check-writing and electronic transaction capabilities that resemble what you'll find from checking accounts and other bank products. Money market funds are designed to keep their assets extremely liquid to allow for these ongoing deposits and redemptions.

But Fitch Ratings yesterday listed some of the challenges that money market funds would face in a default situation. Fitch specifically noted that funds were not required to follow Fidelity's strategy of selling off Treasury securities even in a default situation. What could be problematic, though, is if fund customers greatly increased their redemptions of fund shares in anticipation of an extended waiting period. Such a run on assets would put money market funds in the difficult situation of having illiquid Treasuries in its portfolio while needing to raise cash to pay off exiting shareholders.

Where the opportunities are
Other players in the bond market are prepared to take advantage of money market funds' risk aversion. PIMCO bond maven Bill Gross, who oversees the PIMCO Total Return Exchange-Traded Fund and other funds totaling about $2 trillion under management, told CNBC yesterday that he would take the other side of Fidelity's trade, gladly accepting yields on short-term securities that are 10 to 20 times what they were a few days ago in exchange for some mild liquidity risk. After all, few people have any fear that the Treasury won't eventually pay off its obligations. That's good news for PIMCO ETF investors, but money market fund shareholders won't be happy that PIMCO Total Return's profits are coming at their expense.

For money market fund managers, the debt ceiling drama is just the latest in a long series of challenges. Low rates have forced Federated Investors , Schwab , and many other major money market fund managers to subsidize their funds, accepting reduced management fees just to keep their interest rates from going negative. As the graph below shows, fund levels have fallen sharply in response to those low rates as well, hurting fund managers' profitability.

Money Market Fund Assets Chart
Money Market Fund Assets Chart

Money Market Fund Assets data by YCharts.

Moreover, proposals for new SEC rules governing money market funds identified the investment vehicles as having potential systemic-risk implications, adding further regulatory complexity and restrictions to an already tough business model. That makes it harder for Schwab, Federated, and other industry players to justify the effort and expense of operating these funds.

Do what you should have done long ago
The latest concerns over money market funds only add another reason why you should avoid the vehicles. For years, money market funds haven't been able to match the rates you can get on high-yield FDIC-insured bank savings accounts. Even now, you can get almost 1% on your money at certain banks -- a far cry from the 0.01% you'll get from most money market funds.

Don't let the debt ceiling be a threat to your money. With more protection available at better rates, insured high-yield savings accounts make a better place for you to stash your cash.

Get Your Money Working Harder
One problem is that millions of Americans have far too much cash in money market funds in the first place. Too many investors have waited on the sidelines since the market meltdown in 2008 and 2009, too scared to buy stocks but therefore having missed out on huge gains. In our brand-new special report, "Your Essential Guide to Start Investing Today," The Motley Fool's personal finance experts show you why investing is so important and what you need to do to get started. Click here to get your copy today -- it's absolutely free.

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Fool contributor Dan Caplinger has no position in any stocks mentioned. You can follow him on Twitter @DanCaplinger. The Motley Fool recommends Federated Investors. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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