How Safe are Money Market Funds?

A close look at the actual stability of Money Market Funds

I don’t have a savings account; not a traditional one anyway…

As someone with no debt or dependents I don’t feel I need an overly large pool of savings, and so I keep my “savings” invested in a Schwab money market fund in a separate brokerage account. That way, my returns and my personal finance choices are separate.

I know some banks offer high-yield savings accounts, and those often have competitive-ish interest rates with the MMF’s, but for me money market funds are more simple and effective. I don’t need another financial institution in my life, especially a name I don’t recognize and trust. This MMF may ultimately get me an extra 1% of interest over my life, and i’m good with that.

There’s a bit of a difference, however, between Money Market Funds (not to be confused with money market accounts) and traditional savings accounts:

The F.D.I.C.

See, in a savings account in the U.S (as many of you already know) my money is secured by the Federal Deposit Insurance Corporation (F.D.I.C). This means that i’m insured against bank failure for up to $250,000 - well above the amount I would likely ever have in a savings account.

Money Market Fund’s don’t offer this same sort of crisis guarantee. SIPC insurance doesn’t cover the potential for “breaking the buck” in a MMF.

But lets back up, how do Money Market Fund’s work?

When I buy $1,000 of a Money Market Fund, i’m basically buying into a mutual fund which invests my money in very short term debt instruments (usually T-Bill’s, Repos, and commercial paper). With my Schwab money market fund, it takes 24 hours to clear into actual usable cash. The reason being that the fund needs time to actually go and buy or sell 1,000 bucks worth of short term assets.

Why short term? Well, imagine you own a 30-year T-Bill at 4% and rates climb to 8% over that period. You would be in the red for the entire ownership period until your bond matures in 30 years. Of course, once that bond matures, you are made whole with your 4% annual interest on top of it. But if you wanted to sell that bond early, you would end up selling for a loss or having to wait the 30 years for the bond to mature.

30 years is a long time! 30 days, on the other hand, is a pretty reasonable amount of time to wait, and so short term debt instruments don’t carry the same sort of interest rate risk that long term bonds do. Of course, you also don’t get much upside either if rates move down instead of up. You could theoretically create your own money market fund and actively buy and sell short term debt instruments, or you could just let Schwab or Fidelity do it for you.

This constant turn over of assets means there’s always a lot of cash in the fund. As these <1 year long debt instruments mature, they are turned into cash. And that 24 hour waiting period helps to ensure the fund has a bit of a grace period to meet the cash needs of investors. If lots of investors want out tomorrow, mountains of cash are already scheduled to arrive tomorrow or next week. Moreover, the assets themselves are very low risk with both short maturity periods as well as the underlying contracts themselves being AAA.

It should be noted that the term “AAA” is reserved for longer term debt securities, and the equivalent for “ultra short term” assets like the ones held in MMFs (97% of holdings are super short term) is called A-1 or P-1 (A-1 is S&P and P-1 is Moody’s).

Government regulation dictates that 97% of a money market fund’s assets must be in these tier 1 securities. Moreover, the regulation requires that no MMF can hold more than 5% of a non-government issuer’s paper (the fund can’t be 20% in JP Morgan’s short term debt). Otherwise, a single issuer (be it Apple or Enron) could really break the buck. So there’s built-in diversification here as well (except for the U.S Government of course).

“Breaking the Buck”

I’ve used the term “breaking the buck” here and I should explain. When I buy $1,000 of my Schwab Money Market, I have $1,000 bucks in value - always redeemable for that amount. $1 = $1.

Something going horribly wrong with a money market would result in breaking the buck. Meaning $1 = 99.5 cents (or less). This is a big deal for a money market fund. Back in 2008 there was a fund that “broke the buck” (and it wasn’t Schwab - as they constantly point out).

Back in September of 2008, the Reserve Primary Fund was the world’s third-largest money-market fund with roughly $62 billion in assets. It also happened to hold about $785 million of Lehman Brothers commercial paper. When Lehman filed for bankruptcy on September 15, the paper became effectively worthless, slicing the fund’s net-asset value to $0.97 a share ($1 = $0.97) on September 16. This disaster resulted in the Reserve Primary Fund becoming the first large U.S. money-market fund to “break the buck.” Panicked investors demanded nearly $40 billion in redemptions within two days, forcing the fund to freeze withdrawals and enter liquidation. The episode spurred the U.S. Treasury to issue a temporary guarantee for all money-market funds (to avoid a run), and led the SEC to tighten Rule 2a-7, establishing the modern liquidity, maturity, and disclosure rules that govern funds like SWVXX today. Had the treasury not stepped in, i’m not so sure Schwab could boast as it does about their record.

Now, in the end, investors of the fund ended up receiving about $991 for every $1,000 invested in the fund. That doesn’t sound so bad, right? The problem - and I can’t emphasize this enough - was that investors did not receive that money until 2010! Two years later!!! So that is a bit terrifying if its 2009, you’ve lost your job, and your stocks are all in the toilet.

It should be noted that, after this disaster, the rules for money markets did get tighter. The SEC rewrote “Rule 2a-7” in three big waves.

Firstly (and most importantly i’d say), in 2010, the SEC tightened the fund’s “plumbing,” slashing maximum average maturity to 60 days, capping any single holding at 397 days, and requiring every money-market fund to keep at least 10% of assets in “cash-like” securities that convert to cash overnight and 30% within a week. They also insisted on monthly portfolio disclosures and stress-testing mandates.

Next, in 2014 the SEC went after run-risk. In other words, institutional prime and municipal funds had to float their share price instead of rounding to $1, while all non-government funds gained the power (and, if liquidity fell too low, the requirement) to impose liquidity fees or temporary redemption “gates.”

Confused? Here’s Margo Robbie to explain…just kidding its still me.

Picture a money-market fund like a communal cookie jar. Before 2014 every jar was labeled “$1 per cookie” - no matter what the ingredients inside were worth that day. So, if people worried the cookies might suddenly shrink, the fastest grabbers could empty the jar first and walk away with full-size cookies, leaving latecomers with crumbs. You probably know this phenomena as a “run.” The 2014 rule-change fixed two things:

1. Jars meant for big, sophisticated investors that hold corporate IOUs (so-called “institutional prime” and municipal funds) now have to show the real cookie size each day (maybe $1.0003, maybe $0.9997) so those investors can already see tiny ups and downs and feel less pressure to stage a stampede. After all, people’s fears are usually far greater than reality.

2. Any non-government jar, whether for folks like me or for institutions, is now allowed - or even required if liquidity drops below a certain point - to put up a small toll gate (a 1–2 % withdrawal fee) or briefly close the lid for up to ten days. That pause gives the baker time to restock instead of dumping cookies at fire-sale prices. Government funds and retail prime funds keep the fixed $1 label, but the threat of a toll gate still hangs there as a brake on panic.

In short, this second rule change is like adding banana peels to a bank-run. Its meant to slow, stop, or avoid one entirely.

Finally, in 2023 the SEC decided that money-market funds needed fatter cash cushions and fewer panic buttons (after all, too many panic buttons can make people panic). As a result, it more than doubled the “ready-cash” pile every fund must keep from 10% to 25% that can be turned into cash overnight, and from 30% to 50% that can be cashed out within a week. That way, if lots of investors want their money back at once, the fund already has half its assets sitting in near-cash form. At the same time, the agency took away the “slam-the-lid” option (redemption gates) that let funds freeze withdrawals, since even the threat of a lockdown made nervous investors run faster. Instead, when it comes to big institutional prime and tax-exempt funds - the ones most prone to runs - the SEC now automatically charges a small exit toll if redemptions in a single day top 5% of the fund. That fee lands on the investors who are rushing for the door, not on the ones who stay put. Retail and government funds still keep their $1 price and don’t face that mandatory fee, but they benefit from the thicker liquidity buffers and the fact that no fund can lock anyone in anymore.

Now, I actually get a good deal of comfort from these rule changes. They make a lot of sense, and they put the burden (and cost) of staying calm on large institutions and not average folks.

RISK: How to Break the Buck

Ok, so now that you understand what they are, how they work, and how their regulated, maybe we can try and imagine how to destroy a money market fund. Rather than ask ourselves what are the risks of a money market fund? I think its more fun to try and concoct a perfect storm as if it was designed to destroy my savings. Big surprise, the answer is basically just “recreate 2008.”

For this hypothetical catastrophe, i’ll try and use the Schwab Prime Advantage Money Market Fund: $SWVXX

The set-up for this would be some new sort of financial crisis in which both the equity and bond markets are panicked and credit defaults begin rising.

Step 1: Credit Shock

5% is the maximum amount a money market fund can hold of a non-government institutions debt. If a major issuer (e.g. a large bank or corporate) unexpectedly fails, SWVXX would incur losses on those holdings. Even a few basis points of realized loss on SWVXX’s ~$240 billion portfolio would erode its cushion.

Step 2: Breaking the Buck (PT 1)

As the shock materializes, SWVXX’s portfolio must be marked down. Its market‐based NAV (a daily calculated price) would slip below $1 (for example, to $0.999x), even though the official share price remains $1 by rule. Under today’s rules, MMFs report portfolio info daily, so investors quickly see that SWVXX’s market NAV is impaired. This triggers alarms: the media would have a field day reporting that SWVXX can no longer perfectly preserve $1.00. In practice, seeing any NAV shortfall (even tenths of a cent) scares investors. Remember the Reserve Primary Fund? Those Lehman losses showed how a tiny NAV gap can instigate massive redemptions. For SWVXX specifically, a below‐$1 market NAV means its promised stability is broken in the eyes of investors, prompting the next phase.

Step 3: The Run Begins

In a panic, SWVXX shareholders – mostly individual “retail” investors – rush to redeem. In the 2020 Covid crisis, retail prime outflows reached ~9% of assets (versus only 4% in 2008). With news of SWVXX’s mark value below $1, everyday investors are “more likely to run” on a fund, fearing loss of principal. Critically, modern SEC reforms forbid any gate to suspend redemptions. Every since 2023/2024, SWVXX cannot stop or slow redemptions for these funds. It must pay every investor at $1/share instantly. SWVXX currently holds 25% of its assets in ultra‐liquid cash/government instruments, and 55% can be liquidated within a week (above the 50% regulatory minimum). But even a moderate outflow (10–15% of assets) would quickly exhaust the 25% daily buffer. Because SWVXX has no mandatory liquidity fee (that applies only to institutional prime funds) and only a discretionary fee for retail, none is triggered automatically. The run thus accelerates all at once: investors redeem $1 per share, forcing the fund to liquidate assets to pay out.

Step 4: Forced Liquidation

Now that the run has begun and the cash cushion is depleted, the fund must begin selling assets to meet withdrawal requirements. To meet redemptions beyond its cash buffer, SWVXX must sell securities – first weekly‐liquid assets (repos or short T‐bills), then its remaining private paper. In a severe stress, these sales happen at depressed prices. This of course would turn the paper losses into real losses.

Step 5: Breaking the Buck (PT 2)

Those realized losses drag the fund’s true net-asset value below $1.00. With no way to keep rounding up, the share price slips under a buck and investors still inside the fund now own less than they put in permanently. While initially (in PT 1) this was a theoretically market move which broke or maybe just bent “the buck,” now there is literally not enough money in the fund to ever return to a 1:1 with investor dollars.

Step 6: Clean Up

The board and regulators step in: the fund either converts to a floating NAV or winds down and returns what’s left. Shareholders eventually get most of their money back, but a few pennies per dollar are gone - and access to the cash wasn’t instant. I’m doubtful we would have yet another 2 year wait period for redemptions? But then again, in a situation like this, something much crazier is likely happening in the financial system, and so regulators are busy putting out fires everywhere.

Ok, so thats pretty much what happened in 2008. It might sound bad and somewhat plausible, but there are a few important notes to make now.

Here’s a couple reasons not to worry:

Sponsor Bailout (and this is a biggie): Fund advisers have stepped in hundreds of times - Moody’s counted 62 sponsor bailouts in 2007-08 alone - to top up losses and keep the $1 peg. Schwab isn’t legally obligated to do so, but its brand (and the rest of its $240 billion cash-management franchise) give it a powerful incentive. In short, they spent a good deal of money back in 2007 to be able to tell me 15 years later that their fund had never broken the buck. Thats pretty cool.

Less reason to run: SWVXX now holds at least 25% of assets in “overnight cash” and 50% in securities that turn into cash within a week. If investors stay calm, those buffers easily cover normal redemptions while the manager works out the loss. Breaking the buck in a permanent way isn’t inevitable at all.

One Glaring hole

Ok, my final doom-test. If you hadn’t noticed, there is a built-in assumption that U.S government bonds are at a near zero risk of default. As a matter of fact, regardless of what S&P and Moody’s says, legally these treasury bills are designated as “Tier 1.” Essentially, the Government made it a law that their debt is as good as gold. Does that mean it always will be? Not necessarily.

Now, I abhor the U.S debt burden. If there was a real “pay-off-the-debt” political party I would be the first to sign up. That said, I don’t think that means fear mongering about the debt is going to improve either of our returns. So, I want to take a look at what would happen if the treasury actually missed a payment: I.E, defaulted on the debt.

No surprise….its really bad.

Ok, every year the U.S government plays a game of chicken with our debt-ceiling. Perhaps its all theatre, but lets say someone takes it too far and the U.S actually misses a debt payment of sayyyy $100 billion. Enter the world of technical default:

Treasury misses the payment and those T-bills automatically default. A missed payment turns that bill from “risk-free cash” into a defaulted security. Prime funds like SWVXX and Treasury-only funds that hold near-dated bills must mark them down sharply; government securities lose their automatic “first-tier” status once they are in default.

Traders, seeing this, naturally flee like the devil from any near-dated treasury bills. Yields jump 100–300 bp (as they briefly did during the 2011 and 2013 standoffs, when some bills cheapened by 66 bp in a single day). Government MMFs are 99% in T-bills and repos (collateralized by T-bills). Even a 1% price drop on half the portfolio shaves ½ ¢ off their $1 NAV - enough to “break the buck.” Prime funds use bills for liquidity, so they too take immediate mark-to-market hits.

Then the Repo market kicks into gear. Because many repos are collateralized with T-bills, counterparties demand huge haircuts or refuse the collateral altogether. The Fed warned in 2013 memos that a default could “compromise the functioning of the repo market.” MMFs rely on overnight repos both as assets and as “ready cash.” If repo liquidity vanishes, funds cannot roll expiring repos into new ones, draining their 25% overnight-cash buffer….just as investors start redeeming.

Investors in Money Market funds (like me) would naturally freak the FUCK out. Headlines about a “defaulted” bill and frozen repo market trigger redemptions. With no redemption gates allowed under the 2023 rules, every fund must pay out immediately. To raise cash, funds dump still-good bills into a market with no buyers, locking in bigger losses. A government fund can’t impose an automatic liquidity fee (that tool is only for institutional prime/muni funds), so the $1 NAV cracks.

Now, this is where the Fed should step in. If they didn’t it would be pretty painful, but with these sorts of assets, we’re still only talking about a maximum ~12% loss. Still quite a loss on something regarded as “risk free.”

Now, I think it should really be noted that this is quite a special situation. It would require a lot of things going very wrong all together. The Government isn’t perhaps the most competent entity on Earth, but they are aware of the systemic risks of missed debt payments. Moreover, the Fed has a long history of stepping in to sure these things up. Not only that, but the market knows the Fed has done that historically. I believe it was treasury secretary Hank Paulson who said,

“If you've got a bazooka, and people know you've got it, you may not have to take it out.”

Honestly, i’m not worried. I know its probably the sexy thing to fear-monger about money-markets and whatnot, but lets be real. The events that must take place in order for an individual retail investor to really feel pain in MMFs are once in a century events. Those events already happened in 2007/2008. In my mind, my risk is near 0. If I had children or higher monthly costs I might have a different personal finance arrangement; one which would likely involve the FDIC.

Realistically, there is just nothing wrong with having savings in a high-yield savings account. I’m not against that even a little bit. My hope was to truly, once and for all, get my head around the actual risks to my cash. The word on the street is that MMF’s are perfectly safe, but that sort of “hearsay” is perfectly useless to me.

I want to know why.

Talk to ya later