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What You Should Know
Money market funds are technically mutual funds, regulated by the Investment Company Act of 1940 (see #43) and subject to price variations based on performance of underlying assets. However, because money market funds invest in very price-stable, short-term debt securities (usually a “weighted average maturity” of ninety days or less), the asset base is extremely stable. As a result, the price of most money market fund shares is $1, and it is highly unusual for such a fund to “break the buck.” It did happen, however, to two funds in the 2008 crisis as a result of investments they had made in failed investment bank Lehman Brothers. Reserve Primary Fund fell to ninety-seven cents and the other, BNY Mellon, fell to ninety-nine cents—so you can see how stable these holdings are.
Most money market funds pay yields based on short-term interest rates, which in 2013 were practically nothing, below 0.2 percent in most cases. In more normal interest rate environments, money market funds pay 0.5 percent to 1.5 percent more than comparable bank savings instruments.
Money market funds are different from the assortment of money market accounts (MMAs) offered by banks. The bank MMAs pay slightly less than MMFs, but are not for the most part covered by FDIC insurance (see #45 Federal Deposit Insurance Corporation). Most money market funds are sold by mutual fund companies or are available through brokers, retirement plan administrators, and others. Most money market funds are taxable—that is, the interest earned is taxable—but some are based on government securities (for stability) or tax-exempt securities (for tax preference). Most MMFs charge modest fees, but in today’s low interest rate climate, even a tenth of a percent makes a big difference.
Why You Should Care
Money market funds are a good place to park reserve cash—reserved either to invest or to handle unexpected emergencies in your personal finances. They offer stability and liquidity, and did offer somewhat better yields in the past.
77. CREDIT RATING AGENCY
Credit rating agencies are specialized companies that evaluate the financial strength of other companies and of the debt instruments they issue. These ratings are used by banks, lenders, and others interested in corporate strength to judge the safety and quality of debt. While credit rating agencies are important to the proper function of the financial system, they might not have been mentioned in this book, except for the large role they played in the 2008–2009 financial crisis and the Great Recession that resulted.
What You Should Know
Credit rating agencies evaluate the overall strength of credit and credit risk of a company, similar to the so-called “credit rating” you might receive as a consumer, and they also evaluate the strength and quality of specific debt issues, like bonds or commercial paper. The “big three” ratings agencies evaluating U.S. companies are Standard & Poor’s, Moody’s, and Fitch Ratings. They each have their own set of rating criteria, and each issues ratings more or less analogous to school letter grades, although the exact grading scale used by all three is different. Companies will usually get a credit risk rating as a whole, and most large corporations are rated by all three agencies. Individual securities will also get ratings, but typically from only one agency. Special securities issued by companies, like asset-backed securities (see #67), also get ratings, and it was these ratings that brought credit rating agencies into the spotlight after the financial crisis.
Credit ratings are, in theory at least, convenient and independently calculated tools to help others make fast decisions about whether to lend to or invest in companies. For the most part they work, and have been the standard for years. But ratings agencies and their ratings came into question in the wake of the 2008–2009 crisis for two primary reasons. First, they tend not to change fast enough to reflect current economic or corporate conditions. Second, and perhaps more damaging, is the apparent conflict of interest in their creation: the firm issuing securities hires the rating agencies to provide the rating. Naturally, the agencies try to please their customer for the sake of future business and the business relationship. But those attempts to please have been called into question, particularly with the number of highly rated mortgage-backed securities that blew up in the crisis.
To be fair, it isn’t just the conflict of interest at fault—most likely, these securities were just too complex, and backed by assets too difficult to value, for any such rating to be accurate. Legislative reform of the ratings agencies has been slow in coming, but since reputation is the chief asset these companies have to sell, there has been a fair amount of self-reform, and their public image and effectiveness has returned to a large extent since the crisis.
Why You Should Care
Agencies rate debt securities that ultimately may include loans or mortgages you take out, and the ability of a rating agency to rate them fairly will determine how easily they can be sold to investors, ultimately affecting your ability to get financing. So there’s no direct impact on you or your household, but ratings agencies are part of the machinery that makes financing—money—available to you at an appropriate price.
78. STOCKS, STOCK MARKETS, AND STOCK EXCHANGES
As recently as 1960, only about 10 percent of all households owned shares of stock in corporations. Today, due in part to individual retirement savings needs, that figure has grown to exceed 50 percent; that is, one in two households across the United States own shares of corporations.
The discussion of stocks and stock markets ca
What You Should Know
Stocks can be listed on stock exchanges if they meet certain criteria in terms of size, volume, and share price given by the exchange. The exchange is a corporation or organization set up to bring buyers and sellers together, either in person or electronically. The exchange handles all incoming orders, executes them by matching a buyer to a seller, and routes the proceeds as funds to the appropriate parties.
The two major U.S. stock exchanges continue to be household names: the New York Stock Exchange (NYSE EuroNext) and the NASDAQ, which originally stood for the National Association of Securities Dealers Automated Quotations. In addition, the over-the-counter (OTC) and Pink Sheets markets and a series of regional exchanges handle specialized trading situations in the United States, and a network of online-only electronic exchanges has emerged, such as BATS Global Markets and Direct Edge, which have recently a
How stock trades are actually executed varies by exchange. The original approach begun in the early 1790s on the corner of Wall and Broad Streets in Lower Manhattan eventually became the mainstay of the NYSE. That approach uses a specialist—an individual with assistants who manually matches buy and sell orders with each other and with a personal inventory when such external orders don’t exist or are too few. Each stock has one specialist and one only; that specialist is assigned the task of maintaining orderly markets.