When Will the Money Markets Collapse?

In the wake of US banking turmoil, investors are nervous about where to put their vast amounts of pandemic stimulus money. That risk and volatility has pushed trillions out of banks and into Mega Cap equities and money market funds.

Funds in money markets are seemingly more stable with a better rate of return (4% to 5%) than keeping it in a bank, also poses lurking risk discussed in this post. In the event of a recessionary event, such as commercial loan defaults, retail and institutional investors could do a run on these short term funds.

It’s estimated there are more $5 Trillion in money markets today and just this year alone investors have poured $756 billion into cash funds according to Bank of America.

If a recession occurs, investors will sell their stocks and move their funds into the money markets – estimated by Goldman Sachs at $1.1 trillion.

And with all that money in the money market funds, there could be a rush of selling and withdrawals. These funds are not insured by the FDIC so if the weakened funds fail and the investment companies can’t pay their obligations, you can see why panic would ensue.

The recent fears of a run on regional banks is only a drop in the bucket, but could still send a powerful tsunami across the pool of money market funds in the US and in Europe. And with the US on the verge of financial collapse, relying on that failed institution for compensation seems rather foolish.

Deutsch Bank expects default rates to peak in the Q4, 2024. They’re forecasting peak default rates to hit 9% for U.S. high-yield debt, 11.3% for U.S. loans, 4.4% for European high-yield bonds, as well as 7.3% for European loans.

What are Money Markets?

They are composed of Treasury bills, commercial paper, certificates of deposit, repurchase agreements, and short-term government bonds. They serve as a source of short term funding for corporations, governments and financial and banking institutions. They enable the trading of highly liquid, low-risk instruments that mature in under a year and they assist with the overall functioning of the US financial system.

The best of these funds yield returns equal to the fed funds rate, currently between 5.0% and 5.25%.

Vanguard and Fidelity are two well known money market funds.

What are the Actual Risks to Money Markets?

When several factors combine to make money market investment unwise (remember how the money has rushed into them), investors will want to escape fast like air rushing out of a balloon.

Update: US regulators are expected to raise bank capital requirements by 20%. Led by the Federal Reserve, will unveil proposed tougher requirements by the end of June. This reveals their concern about a potential banking crisis, so it’s a good move, which could also put more pressure on the banks financially and reduce lending.

In this interesting video, Prof. Richard Wolff joins Thom Hartmann to discuss how government spending has lead to ballooning infusions into money markets and the dangerous situation when interest rates fall back to low levels. He explains why it may not be a happy ending.

5 Big Risks to Money Markets

Interest Rate Risk: Money market instruments are sensitive to changes in interest rates. If interest rates rise, the value of existing fixed-rate money market instruments may go lower for potential capital losses. If interest rates fall, investors will withdraw to invest in equities, which likely will happen in 2024 as the economy picks up.
Credit Risk: There is a low degree of credit risk. If an issuer of a money market instrument defaults or faces financial instability, investors may suffer losses.
Liquidity Risk: While money market instruments are highly liquid, extreme market conditions or disruptions can create temporary illiquidity. If there’s a mass withdrawal from retail investors or institutional investors, it would put these companies under intense financial pressure and make it difficult to sell the underlying instruments at fair prices.
Regulatory Risk: Changes in regulatory requirements or shifts in the regulatory environment can impact the functioning and stability of money market funds, potentially affecting their returns and liquidity.
Competition: Desperate Banks compete for investment money with the money markets and face failure in that competition since most banks are more risky and pay out less.

If investors keep their money in money market funds as the FED rate falls, it means they are losing value, gaining significant risk, which will necessitate a shift to foreign banks, equities, real estate, commodities and reduced demand for money market instruments which creates a potential collapse which the government must resolve.

As an investor who has invested in the money market funds, when do you withdraw to get a jump on the rest? Where do you plan to put your money? Although residential rental income real estate is expensive, there is too little of it and prices cannot go down.

Stocks may do very well in 2024, but the combined potential of capital appreciation and rental income makes rental property a great target investment. Best to get started with your investigation of the 2024 housing market and the 5 year real estate forecast. And the long term 10 year projections are nice to know.

So be ready when the air is pushed out of the money market balloon in 2024. You’ll have many stories to tell your grandkids how you avoided yet another macroeconomic tragedy.