Sizing up 'safe harbor' money markets

Question: I’ve been hearing a lot of talk of late about the safety of money market accounts, so I’m wondering if the money I have in a money market account with my bank is secure. Is it? —M.S., Atlanta, Georgia

Answer: I think your worries may stem from the possibility that that you’re confusing two types of savings vehicles with similar names. I’m talking, of course, about bank money market accounts and money market mutual funds.

But even though their names sound alike - and investors have historically relied on both as safe places to stash their cash - the fact is that these two vehicles are actually quite different.

So it’s important that you as well as other savers and investors understand which type of account you actually have and what sort of security you can expect from it.

Bank money market accounts

These are deposit accounts offered by banks. Indeed, sometimes they are called money market deposit accounts to differentiate them from money market mutual funds. Essentially, bank money market accounts are nothing more than savings accounts that allow you to write checks (up to three a month) and that pay a higher rate of interest than you would receive on a regular savings or interest-bearing checking account. In return for that higher rate of interest, you must typically maintain a minimum balance, usually between $1,000 and $2,500.

As far as the safety of your money is concerned, the important thing is about bank money market accounts is that they are insured by the FDIC. So if your bank were to fail, the money you have in a bank money market account in your name would qualify for up to $100,000 in deposit insurance, or as much $250,000 of insurance if your money market account is held in an IRA or other retirement account.* (I’m oversimplifying the coverage rules here. For details, I suggest you read a previous column and the deposit insurance section of the FDIC site.)

But the point is that as long as the money you have in a bank money market account falls within the FDIC insurance limits, you will not lose a cent even if your bank goes down the tubes.

Money market funds

These are a type of mutual fund. Unlike stock or bond mutual funds, money market funds invest in very short-term debt securities, including Treasury bills, commercial paper (a form of corporate IOUs), bank deposits as well as more arcane instruments.

Money market mutual funds don’t qualify for FDIC insurance, even if you buy the money market fund at your bank. But the idea is that by limiting themselves to high-quality securities with short-term maturities, money market funds should be able to maintain a stable share price of $1. And with one exception, they’ve been able to do just that, until two weeks ago.

That’s when problems in the credit markets led to one money market fund “breaking the buck,” which means its price slipped below $1 per share. That has led investors to question the safety of these funds, and that accounts for all the talk you’ve heard, although the discussion has centered on money market funds, not bank money market accounts.

Are you protected?

To allay investors’ concerns about money market funds, the Treasury Department has created a guarantee program. designed to protect money market fund shareholders from losses. But this program isn’t as comprehensive as FDIC insurance. For one thing, participation is voluntary; only money market funds that pay a fee to join the program will be covered. Even then, not all shareholders’ money in a participating fund qualifies for the guarantee. The guarantee covers only the number of shares you owned in a participating fund as of September 19. And the program is temporary. It will be in effect for three months initially, and the Treasury secretary has the option of extending it through September 18, 2009.

So far, according to Crane Data, which is keeping a tally of funds that sign up for the Treasury program more than 10 companies, including Schwab, Putnam, Dreyfus and Morgan Stanley, have enrolled or are in the process of signing on to the program. Others are still mulling it until the October 8 deadline. To find out if your money market fund has joined or plans to, you can call your fund company.

Despite the problems that some money market funds have had recently, I still believe they offer a high level of safety, even apart from additional protections that may be afforded by Treasury’s guarantee program. As I’ve noted before, I think your chances of losing money in a money market funds are small if you stick to the funds of large, well-known fund companies that are likely to shore up their fund if it runs into problems. You can reduce those odds even more if you stick to money market funds that invest only in Treasury securities.

But aside from assets guaranteed by the Treasury, this protection isn’t absolute. When the markets are as haywire as they are today, it’s possible to imagine scenarios where even the highest-quality money-market fund could post a loss, although I’d expect it to be small, say, a few cents a share. If that type of scenario, no matter how unlikely, keeps you up at night, then you might want to keep your cash reserves in a money market deposit account that’s covered by FDIC insurance (or accounts at multiple banks if that’s what it takes to assure you’re fully protected).

Then again, if the situation with the economy and the financial system deteriorates to the point where money market funds are routinely breaking the buck, small losses in money market funds may very be the least of our worries.

*Editor’s note: Last night the Senate passed a bailout package that, among other things, would temporarily increase the $100,000 deposit insurance limit to $250,000. For the higher limit to become effective, however, the House would have also to approve it and the president would have to sign the measure.