Is my money safe in my money market fund during this credit crisis?

Lots of people keep a lot of cash in money market funds, presuming that they are as safe as bank accounts, but in fact money in such funds does not have the same kind of FDIC protection, even if the funds are offered by a bank. Nonetheless, the short answer to the safety question is that there isn't even close to a remote chance that any of us is going to have problems with our money market funds during the current "credit crisis."

First, to clarify some terms, the FDIC insurance offered by most banks covers only deposit accounts, which include checking, savings, NOW, money market deposit accounts, and CDs.

Any stocks or bonds or mutual funds or other "investment products" offered by a bank are not covered by FDIC insurance.

It is extremely important to understand that money market funds are not covered by FDIC insurance. Yes, money market accounts (properly called money market deposit accounts) are covered by FDIC insurance, but money market funds (properly called money market mutual funds) are not covered by FDIC insurance since they are an investment product and not bank deposit.

Even if the bank advertises a money market fund, that does not automatically give it FDIC insurance protection.

Also keep in mind that in general FDIC protection covers only the first $100,000 (in deposits) you have in a bank (as an individual), although up to $250,000 (in deposits, not stocks or bonds or mutual funds) is protected in many retirement accounts kept at banks.

A lot of people are very loose with some of these terms, so check and double-check to make sure that you are dealing with a money market account or a money market deposit account that is covered by FDIC insurance, if that is what you seek. Yes, a money market fund or money market mutual fund will tend to offer a significantly higher yield, but it also offers somewhat less absolute protection.

Now we shift to money market funds or money market mutual funds.

Although there is nominally no explicit guarantee comparable to FDIC insurance, money market funds are generally implicitly protected in a number of ways.

First, given that money market funds have a relatively high money flow rate in terms of people frequently adding and removing money from the fund, the managers of these money market mutual funds are forced to invest primarily in very liquid short-term assets, such as T-bills, bank CDs, commercial paper, repurchase agreements, etc., that tend to mature and get rolled over on a very frequent short-term basis. In general, a money market fund won't be holding an asset that matures in more than a year or maybe thirteen months at the outside.

Second, given the short-term nature of money market fund investments, in general the fund holds them to maturity and gets the full cash value, as opposed to a longer-term fund where there may be a significant "turnover" that exposes the fund to market fluctuations in the market-perceived "value" of assets. Fidelity Cash Reserves indicates that its turnover rate is 0.0%. This means that the full cash value of a money market fund with NAV of $1.00 can be withdrawn within no more than one year to thirteen months. Funds tend to keep the bulk of their assets with durations of less than 90 days to handle wild swings of money flows into and out of the fund.

Third, there is a general "promise" by the money market mutual fund industry not to "break the buck." In general the value of a money market mutual fund "share" is exactly $1.00 and higher earnings on investments within the fund results in higher yields and lower earnings within the fund result in lower yields with exactly zero change in the NAV. The manager of the fund keeps a chunk of the earnings, which is why so many investment companies offer money market funds. The "promise" is twofold: 1) to manage the fund so that the Net Asset Value (NAV) of the fund is exactly $1.00, and 2) if for some reason the NAV dropped below $1.00, the manager (the investment company) would make up the shortfall since failure to do so would cause significant reputation harm to the investment company managing the fund.

Most of my cash is currently in Fidelity Cash Reserves (FDRXX.) I'm personally not worried about its safety, but I'll walk through it as an example since I have all of the information at hand. Fidelity has the following "risk" statement for this fund:

An investment in the fund is not a deposit of a bank and is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although the fund seeks to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in the fund. The rate of income will vary from day to day, generally reflecting changes in short-term interest rates. Entities located in foreign countries can be affected by adverse political, regulatory, market, or economic developments in those countries. Changes in government regulation and interest rates and economic downturns can have a significant negative effect on issuers in the financial services sector. A decline in the credit quality of an issuer or the provider of credit support or a maturity-shortening structure for a security can cause the price of a money market security to decrease.

That doesn't provide much in the way of enlightenment, other than to confirm that the fund "seeks to preserve the value of your investment at $1.00 per share" and to give Fidelity an out by declaring that "it is possible to lose money by investing in the fund." Obviously that doesn't sound like a very strong promise, but as I said, it is more of an implicit promise. Sure, the company lawyers might insist that the company is not on the hook, but the industry-wide "don't break the buck" "promise" and the reputation risk of breaking that promise is a very strong incentive for Fidelity to keep the NAV at exactly $1.00 come proverbial hell or high water.

In terms of the rest of that risk statement, we need to examine what assets are actually in the fund's portfolio and to what extent these credit risks and other risks might be very real or de minimis. And to the immediate concern, people want to know if they have any exposure to subprime mortgage-banked securities and other "toxic" securities which might "blow up" and which are causing the denizens of Wall Street so much difficulty lately.

According to the latest (May 31, 2007) semi-annual report for Fidelity Cash Reserves, the asset allocation is was follows:

• Bank CDs, BAs, TDs, and Notes: 57.5%
• CDs: 20.9%
• Bank Notes: 0.1%
• Master Notes: 4.1%
• Medium-Term Notes: 31.1%
• Short-Term Notes: 1.3%
• Repurchase Agreements: 26.0%
• Commercial Paper: 15.3%
• Government Securities: 0.5%
• Other Investments: 1.7%
• Asset-Backed Securities: 1.7%

(Note: I believe that "BA" is Bankers Acceptance and "TD" is Trust Deed, but I saw neither in the actual portfolio listing.)

(Note: Those number add up to 101.0%, as is stated in the semi-annual report, suggesting that there is some kind of 1.0% reserve in the fund. I have no further details on that issue.)

In terms of maturity, Fidelity Cash Reserves was as follows:

• 0-30 days: 67.7%
• 31-90 days: 19.0%
• 91-180 days: 5.0%
• 181-397 days: 8.3%

So, 86.7% of the NAV $1.00 asset value could be paid out in no more than 90 days with absolutely zero risk of having to take a "hair cut" due to short-term market mispricing of any assets. That is reasonably liquid.

The Asset-Backed Securities category raises a flag, but is a rather small slice of the total pie. A second flag is raised when I read that two of the ABSs are CDOs (Collateralized Debt Obligations.) You see CDOs in the news a lot lately, and almost never with a good connotation. The good news is that all of the listed ABSs would have matured back in June or early July. On the one hand I don't like to see ABS/CDO in a money market fund, but the exposure is minimal and maybe not even an issue due to the fact that money market funds tend to depend on maturing of the asset rather than having a tradable market.

As I look through the portfolio details, I do see that the fund has repurchase agreements with Countrywide Financial, who is also in the news a lot lately and rarely with positive connotations, but once again these are rather small holdings and would have matured back in June.

I see that the fund held a small position in CDs from BNP Paribas that mature by October 2, 2007, but that doesn't particularly alarm me. They also hold about 1.7% position in Medium-Term Notes from BNP Paribas, and a small position of Medium-Term Notes in Countrywide Bank.

I see that the fund held about 1.5% of assets in Master Notes from Countrywide Commercial Re Finance, Inc., but they would have paid off back at the beginning of June. Still, it does raise a flag that such a conservative fund would be "gambling" on such a shaky company. I don't like it, but I don't think there is a real risk here.

Repurchase Agreements are usually very safe since they are very short term and do not depend on trading on a market, but it still raises a flag when I read that a number of them are "Collateralized by Mortgage Loan Obligations." The risk with such collateral in a short-term repurchase agreement lies mostly with the owner who has to worry about refinancing when the repurchase agreement matures and pays back the fund. So, no real problem here.

This analysis is as of the end of May, so it may have changed significantly, but my suspicion is that the fund probably has roughly the same composition today. Of course your own mutual fund may have significant different holdings, but I suspect that Fidelity is fairly representative of the types of assets held in most money market funds.

That's it. Yes, I see some stuff in this fund that I don't like, but nothing that actually alarms me, either now, or for the near or longer-term future.

Actually, the good news is that due to the so-called "credit crunch", companies are being forced to pay higher rates on a lot of these repurchase agreements and notes, which could result in higher yields for money market mutual funds. I have in fact seen the yields on a number of money market funds rise in the past week.

Granted, there will always be some extreme "perfect storms" which could give grief to holders of money market mutual funds, but we aren't even close to the conditions needed for such a storm. At this time, I can do nothing other than give a solid clean bill of health for money market mutual funds. That doesn't mean that there might not be some bad apples out there somewhere, but I can state with great confidence that Fidelity Cash Reserves looks rock solid.

-- Jack Krupansky