Money market mutual funds, often referred to as money market accounts, are considered to be a safe liquid investment. However, as the 2008 banking crisis laid bare, money market accounts are technically not 100% safe, and are typically not insured like savings accounts are insured by the FDIC, or even like investment accounts are insured by SPIC.
Mutual funds invest in securities purchased by with money invested by a pool of investors. In the case of money market funds, the types of investments purchased are short-term debt securities such as T-bills and commercial paper. Commercial paper is short-term corporate debt issued by companies for periods of no longer than 290 days.
The short-term nature of these investments provides a significant level of security against default because most corporate difficulties do not arise in such a short time period. Theoretically, if a company began to have difficulties that would make lending to it unwise, they could be seen over a period of time that would be longer than the 290 days that it would take for the money market mutual fund to redeem their securities at full value.
However, there have been major companies that defaulted on their debt seemingly overnight. One of the most recent, high-profile, examples, was the collapse of Lehman Brothers in 2008. Other prominent examples include many Internet companies, and the implosion of Enron.
In order to protect against such unforeseen difficulties, money market accounts diversify their short-term investments among numerous corporations. That way, if one company were to unexpectedly default quickly on its debts, the other investments would still remain solid.
In the case of widespread difficulty in the short-term debt markets, like what occurred in 2008, the price of all short-term securities could fall dramatically, regardless of the health of the individual companies that issued the debt just based on overall market level fears. This resulted in a couple of money market funds “breaking the dollar” in 2008.
Breaking the dollar, or breaking the buck, refers to money market mutual fund’s stated goal of maintaining a value of $1.00 with additional gains returned to investors as “interest” and all losses taken only from pending interest payments. In this way, investors would not lose money while investing in money market funds.
In order to prevent further confidence problems in the short-term debt markets, the Treasury temporarily guaranteed money market mutual funds. The Federal Reserve guarantee which was originally scheduled to expire in October, 2009 has been extended through at least February 1, 2010.