Money Market Interest

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Money market interest is generally very small, because the risk is small. Almost all money market funds have kept the value of each of their shares at $1, which is the standard Net Asset Value (NAV).

Money Market Interest is the Reward for Short Term, Very Low Risk Money

By law money market funds must keep the average maturity of the securities they hold below ninety days, and in practice it's usually more like forty or fifty days. Usually even a corporation that's in long term financial trouble can pay off its short term commercial paper, and the money funds are supposed to buy the paper only of corporations with good credit ratings anyway, so money market funds are virtually free of default risk.

The interest is set by the market and by the Federal Reserve. The Fed doesn't impose interest rates on commercial paper, but by setting the Federal Funds interest rate, it does affect how much interest the market charges corporations for their short term financing.

Therefore, in general your capital is safe inside a money market account. That is, every $1 you deposit will remain worth $1, and it will earn whatever the going rate of money market interest is, which these days is quite small.

The first money market fund failure came in 1994 when The Community Bankers US Government Fund broke the buck. They paid investors 96 cents per share.

During the financial crisis the Wall Street firm of Lehman Brothers had to declare bankruptcy, which happened on Money September 15, 2008.

This was a problem for several money market funds which had invested heavily in short term loans from Lehman Brothers, because now all those notes were worthless. This included the oldest money fund in existence, Reserve Primary Fund.

Breaking the Buck is Worse Than Low Money Market Interest

On September 16, 2008 wrote off its Lehman Brothers loans and saw its assets go down to 97 cents per share. This caused many people to panic and a "run" on money market funds similar to runs on banks in the early days of the Great Depression. People demanded to withdraw their money, and the funds themselves refused to continue to buy up corporate commercial paper.

The uncertainties this generated contributed to the fear and uncertainty of that week, the most traumatic in financial history.

On Friday September 19 the federal government announced it would support money fund NAVs to $1 a share, which helped calm people, though of course in other ways the crisis continued.

Collecting money market interest is not investing, it's just a small reward for accumulating short term savings -- for college, emergency funds, vacations, home loan downpayments and similar purposes.

Next: Money Market Account -- types of money market funds and their regulations.

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