Tuesday, September 11, 2012

What is the Problem with Money Market Mutual Funds

One argument against reducing the interest rate on reserves to zero (as there were for decades before 2008,) is that this would cause problems for money market mutual funds.

What is the problem exactly?

Presumably it would involve banks buying money market instruments (short and safe bonds,) rather than hold reserve balances.  This would tend to drive up the prices and lower the yields on those money market instruments.   And then, the money market mutual funds would earn less on their asset portfolios.

So?    Why can't money market mutual funds handle this situation?





12 comments:

  1. They aren't set up to handle the case where the yield (after subtracting the management fee) is negative.

    Currently, many funds are waiving fees to maintain a 0.01% yield. So the business is less profitable.

    ReplyDelete
  2. Thank you for the response, but I don't see what is the problem. How difficult would it be to debit shares from accounts if the return of the portfolio net of fees is negative?

    I can understand why mutual funds would worry that they would lose customers in that situation, but that isn't the same thing as some kind of technical difficulty.

    It is like the Fed saying that they have their computers set up to take yield bids on government bonds rather than prices, and they don't have negative yields.

    Well, fix it.

    ReplyDelete
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  4. Bill, yes that certainly could be done. But the fund would have to update software, file new prospectuses, get SEC approval, figure out tax implications, etc. It's just something they've never had to deal with before.

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