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Money Market Funds in a Squeeze


As costs rise and interest rates drop, some big players are exiting the business, leaving investors scrambling for safe havens

Money market funds, the investments that individuals, companies, and institutions use to stash cash, look like another victim of the financial crisis. As interest rates drop and costs rise, some financial firms have pulled out of the business. That's leaving investors scrambling to find safe and high-yielding alternatives for their money. "It's a much riskier business than it was deemed a year ago," says Douglas Dannemiller, a senior analyst at Aite Group, a researcher.

The popularity of U.S. money market funds has been part of their curse. As the stock and bond markets fell, investors poured money into them, some $400 billion in the fourth quarter alone. But the flood of cash—and interest rate cuts by the Federal Reserve—has pushed down yields on the funds to record lows. The result: Profits on money market funds, which own an array of ultra short-term investments, are razor thin.

Costs are on the rise, too. Some money market providers have ponied up insurance premiums to the government, not unlike what banks pay to guarantee customers' deposits. It's part of a federal program launched last year after the share price on a prominent money market fund, the Reserve Primary Fund, dropped below $1, or "broke the buck." Financial firms have shelled out almost $1 billion to cover the new fees.

Watching profits erode, some companies, including Credit Suisse Group, (CS) Munder Capital Management, and Calamos Investments (CLMS) are exiting the money market business altogether. Janus Capital Group (JNS) shut down funds that catered to large institutions and companies but still has funds for individual investors. "Exiting the business significantly reduced our balance sheet risk," says Janus spokesman James Aber. Other money managers have closed funds to new investors—big and small—to keep the extra money from hurting existing shareholders.

A BRIGHT FUTURE?

The business likely will recover "when interest rates rise again," says Brian Reid, chief economist of the Investment Company Institute, the industry trade group. Costs will drop, too, since the government's insurance program is probably temporary. "This is a product that has gone from nothing to being a core part of the economy over the last 30 years," says Vanguard Chairman John J. "Jack" Brennan. "I think this will be a far bigger business 10 years from now."

Until the environment improves, the options for cash are limited, a problem that's especially acute for companies and large institutions. Big investors are fearful of auction-rate securities and enhanced cash funds, debt investments that promised safety and higher yields but blew up amid the credit crisis. That's why some companies are parking their cash in bank accounts that don't pay interest. In essence, they're paying to keep their money safe. "Old-school products that the savvy investor may have pooh-poohed in the past have seen a resurgence," says Pauline Modjeski, president of Horizon Cash Management, a Chicago-based financial that invests cash for hedge funds.

Others are buying "jumbo" certificates of deposit with $100,000 minimums, investments designed for big institutions. Pitney Bowes recently bought short-term CDs yielding roughly 2.5%. Helen Shan, the treasurer of the mail management company, is looking at other types of investments but isn't willing to take on more risk: "There are no heroes in this environment."

Kalwarski is Numbers department editor at BusinessWeek.

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