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Primer on Bank Deposits and Charles Schwab Money Market Funds

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The safety of our clients’ money is top of mind following the failures of Silicon Valley Bank and Signature Bank, not to mention the near failure of Credit Suisse before its emergency bailout by UBS. The bank failures put the FDIC’s $250,000 insurance cap in the spotlight and created a panic within regional banks as customers moved deposits above the FDIC insurance cap to larger, systemically important banks. While the outflow of deposits has slowed, we think consumers are likely to continue to move bank deposits into money market funds. In addition to higher yields for money markets relative to bank deposits, money market funds are generally insulated from a financial institution’s failure because they are held in brokerage accounts.

A Look at Brokerage Accounts

Brokerage accounts aren’t bank deposits. The brokerage firm acts as custodian and houses a client’s assets, which remain in the client’s legal possession. When a client deposits money in the bank, that is a liability for the bank. Technically, the client is lending money to the bank, and the bank uses the money to earn a “spread” by buying bonds or making loans with higher yields than they pay depositors. If the bank fails, it could potentially default on that liability; the FDIC insurance fund exists both to guarantee deposits up to its cap, and to discourage bank customers from withdrawing funds en masse which would be destabilizing for the financial system and the economy. Assets that reside within a brokerage account, including money market fund balances, however, are simply assets under the brokerage firm’s supervision. It is no different than owning a stock or bond at a brokerage firm. The brokerage firm cannot default on it, which means it cannot evaporate if the brokerage firm fails.

Brokerage firms have their own insurance via the Securities Investor Protection Corporation, or SIPC. This insurance protects against the loss of cash and securities in a brokerage account, up to $500,000 total and $250,000 for cash specifically. This is a safeguard in the event the firm fails and there are securities missing from your account. How could this happen? Fraud and theft are the best examples. Bad record keeping, illegal or unauthorized trading are other examples. Outside of the realm of criminal activity, accounts with margin enabled may have pledged securities as collateral for a small yield; these could be lost if the bank failed.

Schwab has stated that securities will not be borrowed out of any account unless the account is margin-enabled and has a current loan balance. Cash that is not swept into a money market strategy, such as Schwab Value Advantage SNAXX or SWVXX, falls within FDIC coverage as they are bank deposits of Charles Schwab. Schwab utilizes a multiple bank charter feature that extends FDIC coverage across Charles Schwab Bank and Schwab Premier Bank, extending FDIC coverage across the two bank charters. 

What About 401(k)s?

For participants in defined contribution plans like 401(k)s, etc., there is an added layer of protection through the Employee Retirement Income Security Act (ERISA). Because 401(k)s and the like are custodied at SIPC-member brokerage firms, they have the previously mentioned protections. But on top of this, they also have protections against the plan administrator violating their legal duties. Investing isn’t risk-free, so none of these provisions protect against volatility and the risk of loss from the changing value of securities.

Overview of Money Market Funds

Money market mutual funds, however, are designed to have a stable net asset value (NAV), pegged at $1.00/share. The idea of a money market mutual fund is that they won’t “break the buck”—have their NAV dip below $1.00. During the great financial crisis, on September 16, 2008, the original such fund, the Reserve Primary Fund, broke the buck when its NAV fell to $0.97 cents per share. The fund had a $785 million allocation to short-term loans issued by Lehman Brothers. These loans, known as commercial paper, became impaired when Lehman filed for bankruptcy, causing the NAV of the Reserve Fund to fall below $1. The U.S. Treasury guaranteed investors that the value of each money market fund share held as of the close of business on September 19, 2008, would remain at $1 per share. Later, during the height of the COVID-19 crisis, the Federal Reserve also issued a blanket guarantee of the assets of money market funds. Since issuing commercial paper is vital to the working capital (and thus short-term operations) of many businesses, and because money market funds are among the chief buyers of these assets, we believe financial regulators stand ready and willing to backstop money market funds again should the need ever arise.

It may be helpful to provide an overview of Schwab’s money market funds for clients. Schwab has three money market fund types: Prime, Government and Treasury and Municipal. In general, we believe Schwab is well capitalized and an excellent custodian for our clients’ assets. However, money market funds are not technically guaranteed instruments and we thought it would be helpful to review the differences between the types of funds.

Prime funds invest in high-quality, short-term money market securities issued by the U.S. and foreign entities, including corporations, financial institutions, and the U.S. government. Typical investments are commercial paper (short-term corporate loans) and certificates of deposits issued by banks. Prime funds are most at risk of breaking the buck, but we believe Schwab’s management of these funds makes the risk of breaking the buck quite low. Examples include Schwab Value Advantage Money Fund – Investor Shares (SWVXX) and Schwab Value Advantage Money Fund – Ultra Shares (SNAXX). There is a $1,000,000 minimum initial investment for Ultra shares.

Government and Treasury funds invest in short-term U.S. government debt securities with holdings in U.S. Treasury obligations or repurchase agreements. These funds, while not technically guaranteed, are the least risky because their underlying investments are government-backed. Examples include Schwab Government Money Fund – Investor Shares (SNVXX), Schwab Government Money Fund – Ultra Shares (SGUXX), Schwab Treasury Obligations Money Fund – Investor Shares (SNOXX), Schwab Treasury Obligations Money Fund – Ultra Shares (SCOXX), Schwab U.S. Treasury Money Fund – Investor Shares (SNSXX) and Schwab U.S. Treasury Money Fund – Ultra Shares (SUTXX). There is a $1,000,000 minimum initial investment for Ultra shares.

Municipal funds invest in short-term municipal money market securities issued by states, local governments, and other municipal agencies. These funds, while not technically guaranteed, are low risk because state and local governments have taxing authority to shore up fiscal imbalances if needed. These are considered general obligation (GO) bonds. These funds also can own revenue bonds, which are backed by the underlying cash flows of a government project such as a utility, toll road, or airport. Municipal bonds owned by money market funds are very short duration and close to maturity. Examples include Schwab Municipal Money Fund – Investor Shares (SWTXX) and Schwab Municipal Money Fund – Ultra Shares (SWOXX). There are also funds like Schwab AMT Tax-Free Money Fund – Investor Shares (SWWXX) and Schwab AMT Tax-Free Money Fund – Ultra Shares (SCTXX) which are designed to be AMT Tax-free. There is a $1,000,000 minimum initial investment for Ultra shares.

We hope this brief primer on FDIC/SIPC insurance and overview on money market funds is helpful. Please contact your WMS advisor if you have additional questions.