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Tuesday, October 18, 2011

The WSJ Uncovers Dangers in Money Funds

News summary by MFWire's editors

Money-market funds, once safe havens for investors, have become "systemic" institutions with the potential to cause serious damage to the financial system, the Wall Street Journal reports.

She boils the case down to "risk" and three misperceptions that she aggues need to be addressed in any reform.

  • Shareholders think money market funds are safe. But the funds do not carry FDIC insurance.

  • The stable NAV reinforces the perception of safety.

  • Foreign banks issuing debt to money funds (she does not explicitly state this action causes more risk, but she imlplies it).

    Case in point: According to the author, Francesco Guerrera, after the Lehman Brothers Holdings Inc. collapse, money markets were badly hit by the near-failure of the $62 billion Reserve Primary Fund.

    In more recent times, U.S. investors "have been gripped by concerns over these funds' exposure to the wobbly European banking sector," wrote Guerrera, resulting in spooked shareholders in the European lenders, specifically French lenders.

    Also, the Guerrera raises concerns about foreign banks, which mostly don't have U.S. deposits and fund dollar loans by issuing debt to money funds.

    "By borrowing short-term funds and lending them out for years banks leave themselves far too exposed to changes in interest rates, credit markets and economic conditions, as shown by European lenders' current plight," she wrote. 

    Edited by: Hung Tran

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