Is your money safe in the PayPal Money Market Fund?

An October 17, 2007 Reuters article by Tim McLaughlin entitled "EBay customers' cash linked to risky assets" suggests that there is some significant risk to money that customers may have in the PayPal Money Market Fund, but I would challenge that assertion, if for no other reason than there is some confusion over terminology. I personally went through the list of holdings in the most recent PayPal Money Market Fund report back on August 19, 2007 and although there is a fair amount of commercial paper, that is normal and typical, and fairly safe since it is all short-term stuff, and much of the holdings in the report would already have matured by now. It is important to distinguish the difference between an SIV (Structured Investment Vehicle) and the assets that an SIV produces and markets. Even for most of the SIVs in the news, the problem is that there is no sense of the overall credit quality and pricing for the totality of assets in the SIV, not a problem with specific assets in the SIV or created and marketed by the SIV, most of which are fine anyway. Short-term commercial paper is almost literally as good as cash and is not the source of the SIV problems.

The article does almost hint at that distinction at one point:

Cheyne Finance LLC, a SIV run by British hedge fund Cheyne Capital Management Ltd., had $145 million of its commercial paper in the Barclays-run money market master portfolio at midyear. Since then, Cheyne Finance has liquidated assets and wound down operations just weeks after its AAA-rated ratings were affirmed.

In other words, the SIV has created and marketed the commercial paper and the money market fund is investing in that paper and not in the overall SIV itself. My law (SEC regulation), retail money market funds are required to invest in only short-term assets (397 days or 13 months), so by definition no retail money market could invest in an SIV itself. Yes, an SIV can contain a lot of bad apples, but money market funds are not permitted to go near most of those bad apples. Yes, the PayPal fund did have some (small amount of) money in CDOs and asset-backed securities, but once again that was only short-term assets, not the kind of risky subprime mortgages that are causing SIVs to be such heartburn.

The article opens by telling us that:

EBay Inc (EBAY.O: Quote, Profile, Research) customers who park extra cash in a nearly $1 billion PayPal money market fund are exposed to the same type of assets targeted for an emergency bailout by the largest U.S. banks, regulatory filings show.

PayPal Money Market Fund, whose popularity has mushroomed with online consumers, is invested in a portfolio that contains structured investment vehicles, or SIVs, linked to troubled subprime loans and other debt.

The risk surrounding these illiquid assets has forced the largest U.S. banks to attempt to create a roughly $80 billion rescue fund to prevent SIV assets from plummeting in value.

The PayPal fund was No. 2 among 248 first-tier retail funds over the past five years as of September 30, according to iMoneyNet. Many other money market funds are also exposed to risky assets in the hunt for better returns, experts said.

To be crystal clear, the so-called bailout is targeting SIVs, not all of the assets contained in or created and marketed by SIVs. Banks have exposures to SIVs and it is those bank exposures that is being bailed out. To repeat, SIVs have a nebulous range of quality in assets and it is the risky, unpriceable assets that are the problem, not the short-term commercial paper that money market funds invest in.

It is absolutely 100% incorrect to claim that "Many other money market funds are also exposed to risky assets" since there is negligible risk due to the short-term nature of the assets that money market funds can invest in. Money market funds are not exposed in any way to the riskier assets in SIVs.

It is absolutely 100% categorically false to claim that "PayPal Money Market Fund... is invested in a portfolio that contains structured investment vehicles" since by definition no SIV would be "contained" in any money market fund. The whole point of an SIV is to create and market short-term assets such as commercial paper in order to finance the riskier long-term securities. Neither PayPal nor any other money market fund invests in any SIV. It is categorically incorrect to confuse the concept of an SIV and the specific assets held by and marketed by an SIV. The correct statement would be that "PayPal Money Market Fund... is invested in a portfolio that contains short-term commercial paper issued by structured investment vehicles." To repeat, the problem is not with that short-term commercial paper, but with the overall valuation of the SIV itself due to the riskier long-term securities.

Oddly, the article does not even bother to quantify the alleged exposure to "risky assets."

The answer to my headline question is that Yes, your money is quite safe in the PayPal Money Market Fund. Shame on Mr. McLaughlin for such a lame attempt to unfairly frighten consumers.

That said, I would note that the 7-day yield for PayPal has now dropped somewhat below 5%, making PayPal uncompetitive with Fidelity.

-- Jack Krupansky