Wary of bank stability, investors shovel huge dollars into money market funds

Cash may be king, but it sat backseat for investors during the recent bull stock market. Now the banking crisis is moving the sovereign back to center stage. 

Investors shoveled more than $238 billion into U.S. money market funds in the wake of two bank collapses, racing to protect their money amid worries about the stability of regional and small banks and the potential for a recession.

The conservative funds, an alternative to bank deposits, took in more than $117 billion over seven days ending March 22, according to Investment Company Institute data. The prior week ending March 15, they took in nearly $121 billion, what Refinitiv Lipper called the fifth-largest draw on record. The figures, net of withdrawals, are the biggest inflows since the COVID-19 pandemic surged in early 2020, ICI data shows. The cash-like funds now hold a record $5.1 trillion.

The surge is "evidence of people who are either concerned about the liquidity of banks or have deposits over the FDIC limits," said Brian Kuhn, a senior vice president and financial advisor at Wealth Enhancement Group in Fulton, Maryland.

Investors began piling into the funds on March 9, the day that shares in Silicon Valley Bank, the nation's 16th-largest bank, plunged. By contrast, in the week ending March 8, money-market funds had outflows of $23 billion.

While the bulk of the cash tsunami is coming from institutional investors, including exchange-traded funds, retail investors are also surging in. They funneled $15.2 billion in the week ending March 22 and $20.1 billion during the prior seven days. 

At least some of the influx appears to be coming from savers shifting out of bank deposits. Between March 9 and March 16, as the banking crisis picked up steam, depositors yanked $98.4 billion from U.S. banks over the week ending March 15, Federal Reserve data show.

'Perfect storm'
The Federal Deposit Insurance Corp. insures bank depositors up to $250,000, per depositor, per account and per bank. So spreading money between accounts and financial institutions greatly increases the total protection. Nearly all U.S. banks are FDIC-insured, so a saver with accounts under the six-figure limit are legally covered. 

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Money market funds aren't FDIC-insured, unlike their cousins, bank-run money market accounts. Because they're securities, the funds are instead backed by the Securities Investor Protection Corp. for up to $500,000 in securities and up to $250,000 in uninvested cash.

So why are investors piling into the funds?

Because amid fears of contagion over the last two and a half weeks, banks haven't seemed that safe to some investors — even when they're FDIC insured.

"I guess they're concluding that they would rather have some limited investment risk than rely on the banks or the banking system to guarantee their deposits over the limits," Kuhn said.

The collapse of Silicon Valley Bank and Signature Bank of New York earlier this month raised the likelihood of a recession, which in turn further pressures banks, Brett Nelson, the head of tactical asset allocation for the Asset & Wealth Management Investment Strategy Group at Goldman Sachs, wrote March 23. Small- and mid-sized banks account for around half of all U.S. commercial and industrial lending, about 60% of residential real estate lending, 80% of commercial real estate lending and 45% of consumer lending, he wrote.

Money market funds are mutual funds that invest in safe securities like U.S. Treasury bonds and high-quality, short-term corporate debt, and pay dividends. Sold by banks and brokerages, they've been seen since 2008 as a fool-proof alternative for storing cash and avoiding stock market volatility. Their rates, sometimes topping 4.5%, are far above the few basis points that savings accounts offer. The funds are typically held for 13 months or less.

The funds, along with certificates of deposits and Treasury bills, benefited from interest rate increases that began in March 2022 as the Federal Reserve sought to tame inflation. The bank turmoil has given them extra appeal.

"It's really kind of a combination and a perfect storm where everybody's been so accustomed to earning nothing on cash and all of a sudden, we're getting something quite meaningful," said Dan Pazar, an executive vice president at Taiber Kosmala & Associates, an investment manager in Chicago.

'All the sense in the world'
Money market funds come in two flavors. The taxable variety typically invests in corporate commercial paper, securities companies use to finance expenses like payrolls and inventory. Tax-free ones usually put investors' dollars into municipal bonds that don't throw off tax bills.

Taxable funds usually have higher returns, in part to compensate for their corporate debt holdings that aren't backed by the government. As such, an affluent investor can see her higher tax bracket eat up the extra profit. Meanwhile, an investor in a lower bracket can eke out extra gain. 

For investors in a 24% tax bracket or lower, "it makes all the sense in the world to be in a taxable fund, knowing that you're making more even after you pay taxes," Pazar said. "A lot of people don't necessarily understand how a money market fund works versus holding cash at your brokerage."

On the other side, an investor in a tax-free fund sees lower returns, but the fund's holdings are backed by the government.

Wall Street banks benefit
With the funds, Wall Street banks have pulled in hefty sums. JPMorgan's U.S. Government Money Market Fund, which invests in high-quality, short-term securities that are issued or guaranteed by the U.S. government or U.S. government agencies and instrumentalities, took in $28 billion from March 8 through March 24, when it had $223 billion, a company spokesperson said. The bank's 100% U.S. Treasury Securities Money Market Fund, which invests in T-bills, took in $24.9 billion over the same period, growing to $119.6 billion in assets.

The flows over the past two weeks comprise a hefty chunk of recent annual flows. U.S. money market funds drew in a net $407.7 billion in 2021 and $683.8 billion in 2020, according to Morningstar Direct. Last year, the funds had net outflows of $54.6 billion in part as many funds saw their net asset value fluctuate widely as interest rates spiked.

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New rules in 2014 aimed at preventing a surprise exodus of investors required "prime" funds aimed at institutional investors to abandon their fixed $1 share price and instead let their price "float." Prime funds invest in corporate debt. Prime funds geared to retail investors are allowed to keep a $1 share price peg, and most do. 

The rules also permitted money-market funds to block investors from withdrawing cash during market and economic volatility. The sea change came after the Reserve Primary Fund "broke the buck" in 2008 during the financial crisis and could pay investors only 97 cents on the dollar. The Federal Reserve made depositors whole.

Since then, money-market funds haven't had any trouble. 

"We find little evidence that investors respond by withdrawing funds if NAV falls below $1," a BlackRock managing director, Ananth Madhavan, wrote last December, referring to a fund's net asset value of $1 per share.

Regulators, citing a "systemic risk exception," made an extraordinary move on March 12 to fully backstop all depositors at Valley Bank and Signature Bank, no matter how much money they kept at the institutions.

But investors soon grew rattled when Treasury Secretary Janet Yellen made statements that seemed to contradict each other. Yellen said March 16 that not all deposits at other banks that might stumble would be similarly guaranteed, regardless of size. Then on March 21, she said depositors could be protected over the $250,000 limit if a bank's collapse posed a risk of contagion for other banks. One day later, she appeared to flip-flop, telling lawmakers that she hadn't considered "blanket insurance or guarantees of deposits."

Amid the murkiness, some savers voted with their feet. With the money-market fund influx, Kuhn said, "It could just be somebody with a lot of cash, or somebody who just worries about the banking system, regardless of their FDIC coverage." 

In a March 24 note, RBC Wealth Management wrote that "More depositors than normal are demanding their cash, driven by fear of bank failure. It's a classic bank run that the existence of deposit insurance is supposed to avoid."

Regulators took over Silicon Valley Bank on March 10, one day after depositors yanked their cash as the bank's stock cratered, an unspooling that came barely 24 hours after the bank announced a surprise plan to sell new shares to raise capital and sell a chunk of its bond holdings at a discount. It was the largest bank failure since Washington Mutual in 2008. First Citizens BancShares of Raleigh, North Carolina, acquired chunks of Silicon Valley Bank last Sunday.