An article in the Sunday Business & Finance section incorrectly described the reserves the Federal Deposit Insurance Corp. has set aside to insure bank deposits. FDIC's reserves amount to 1.25 percent of insured bank deposits.
The proliferation of new types of investments paying market interest rates has put millions of dollars into the pockets of savers who've jumped at the chance to earn 12 or 13 percent instead of the 5 1/2 percent paid on old-fashioned savings accounts.
But record failures of financial institutions, warnings from federal regulators and harsh criticism by competitors are starting to give savers doubts about the safety of high-yield investments.
Is an "insured variable rate account" at a savings and loan association as safe as a money market fund that invests only in government securities?
Are money market funds riskier than the "retail repurchase agreements" offered by banks and savings institutions?
Is a private insurance program as good as the backing of the Federal Deposit Insurance Corp. or the Federal Savings and Loan Insurance Corp.?
Since the various market rate accounts all pay pretty much the same interest and put their money in closely related investments, does it make any difference which one a saver selects?
"There is no practical difference to the investor between a repo and a money market fund, so long as the repo issuer is solvent," declared Frank A. Thompson, associate professor of actuarial science and insurance at the University of Cincinnati.
That means the small investor wishing to earn a few percentage points more interest than is paid on federally insured deposits should be concerned with the financial stability of the institution offering the account.
Both the Securities and Exchange Commission, which regulates most investments, and the Investment Company Institute, the trade association for money market funds, have issued stong warnings about possibly misleading advertising for high interest savings plans.
The Investment Company Institute complained that the Federal Home Loan Bank Board has failed to monitor disclosure by savings associations. It also asked the SEC to crack down on banks and S&Ls engaged in "major advertising and marketing abuses" leading to "unfair competitive advantages over the mutual fund industry . . . "
According to the ICI, "perhaps the most flagrant and widely advertised examples" of advertising abuses have been made by savings associations insured by the private Maryland Savings Share Insurance Corp.
ICI strongly suggests that MSSIC insurance may be insufficient. "Given the widespread advertising of these Maryland 'funds,' the assets of a single one of them could quickly exceed the total assets of the MSSIC," the group warned.
Government Services Savings and Loan in Chevy Chase alone has $100 million in such accounts, the mutual fund association noted. "When the failure of a single fund could conceivably wipe out the entire insurance pool, the advertising of these products as insured appears to be seriously misleading," complained the money fund representatives.
Charles C. Hogg, MSSIC's executive vice president, said 18 Maryland institutions have insured assets of $313 million in money market accounts. Money market rate acounts are insured just like any other deposit by MSSIC.
A private company that is not backed by the state, MSSIC has assets, reserves and a line of credit totaling $216 million to insure $3 billion in total deposits. The insurance fund amounts to 7 percent of the total insured deposits.
In contrast, the Federal Savings and Loan Insurance Corp. has a $6.6 billion fund to insure $527 billion in deposits -- 12.5 percent of the insured deposits -- plus the backing of "the full faith and credit" of the U.S. government.
Federal regulators won't comment on the money funds' complaints, and savings and loan exectutives dismiss them as merely part of the competition for accounts.
Similar warnings, however, were voiced by the SEC, which recently took the unusual step of making public details of its investigation of Fidelity Savings and Loan of California, which was taken over by federal regulators last April to prevent its collapse.
The SEC concluded that Fidelity made "apparent false and misleading statements" in connection with the offer and sale of retail repurchase agreements, known in the new jargon of investments as "repos".
When federal regulators stepped in, Fidelity had $67 million in repos outstanding. If the government had let Fidelity go under, the uninsured repo owners could well have lost their money.
Repurchase agreements and similar investments are being offered by more and more banks and savings institutions to compete with money market mutual funds. They present a way to avoid government restrictions on the rate of interest that can be paid on short-term deposits of less than $100,000.
When banks and thrifts created investments to compete with money market funds, they made them resemble money funds as closely as possible, even in their names: money fund account, market fund or variable rate fund are often-used terms for repos and other imitators of money market funds.
Like money market funds, all these vehicles invest in U.S. government securities, certificates of deposit, bonds and commercial paper. Banks and thrifts sometimes add mortgages to the list. Since the investments are similar, so are the yields, although the interest may be quoted in different ways, giving the impression that some institutions pay more than others.
Repos are not deposits, but rather shares of a pool of securities. The issuer of a repo promises to "buy it back" and return the investor's money plus interest at a given time.
Repurchase agreements are for short periods -- eight to 89 days is common -- but when one matures, another can be purchased automatically, giving the same effect as a money market fund.
Money market mutual funds are required by law to return to the investor all the interest they earn minus fees and expenses. Money market funds offered by savings institutions have no such legal obligation, but for competitive reasons they pass on about the same share of the interest.
The legal difference becomes apparent -- and important -- in the unlikely event of a failure by the issuer.
Money market funds are not insured against market loss or default. The investor stands to lose money if the managers make bad investment decisions or lose money for any other reason. In the past decade only two money market funds have had serious trouble; in only one case did investors lose any money and then only six cents on the dollar.
Many repo advertisements claim that while they are not insured by the federal government, the saver's funds are "guaranteed" (against default) because the money is invested in U.S. government securities.
A similar claim is made by money market funds that invest only in government securities. Sales of government-only money funds has jumped by 83 percent in the first half of this year, far outstripping the growth of standard funds that invest in less safe securities.
The "guarantee" claimed is simply that in the event of a total collapse of the economy, the federal government would stand behind its debts. Direct Treasury obligations would be paid off first while it would take a little longer to collect on securities issued by agencies such as the Government National Mortgage Association. Although Federal National Mortgage Association offerings often are included under the "guaranteed" heading, they have no government guarantee.
In a letter complaining to the Securities and Exchange Commission about repos used by money market funds, Rep. Benjamin Rosenthal (D-N.Y.) declared, "It seems both appropriate and essential that the public be informed, not only by prospectus but also in all advertising and promotional meterial, of a mutual fund's intention to invest heavily in repos. In addition, fund prospectuses should disclose that such investments are not equivalent to direct investment in government securities and may entail risks to which short-term government securities themselves are not subject."
According to Thompson, a repo isued by a bank may be less safe than a money market fund in the event of a failure because customers with insured deposits will be paid off first. Repo holders will have to get in line behind depositors to get their money, whereas in a money fund all investors are treated equally.
The SEC said it is essential that the purchaser know the financial condition of the institution that is issuing the repo with a "guaranteed" repayment.
The Federal Home Loan Bank Board requires savings institutions to disclose whether their net worth is below the agency's minimum requirement. Fidelity's repo purchasers, the SEC noted, were deceived by misleading statements it issued about its condition.
In practice it is difficult for the average customer to determine the financial condition of a mutual bank or savings and loan, since this information is not readily available. Disclosure of condition in ads is rare, and repo contracts can be difficult to decipher.
The mutual funds association claims banks and S&Ls really are acting as investment companies selling securities and as such should be required to abide by SEC disclosure rules.
Money magazine gives government-only funds an A+ on safety from default and Money Fund Safety Ratings' Chairman Glen King Parker agrees. Beyond that, the degree of safety is debatable. In Thompson's opinion, an investment in an insured variable rate account by a depository institution is equivalent to one in a money fund that invests in other types of paper besides Treasury securities.
The mutual fund industry is not the only one to question the adequacy of MSSIC insurance. "I am less than confident that the state of Maryland will find it appropriate to help out-of-state investors in Maryland institutions" in case of failure , said Parker.
One of MSSIC's members, Fairfax Savings and Loan of Baltimore, says 70 percent of its investors live outside the state.
Thompson, too, warns that investors should not rely on insurance. "You're back to being an investor," Thompson said. "It used to be when you put your money into a bank or S&L, you didn't have to worry you were going to be paid. Nowadays, if you go for the higher yield, you should be aware you are taking some risk."