In 1974, following the sharp run-up in oil prices, the world held its breath wondering whether the international financial system could handle the transfer of about $60 billion from oil-consuming to oil-producing nations.
During the last two months, nearly four times that amount has shifted within the U.S. economy with hardly a ripple, as investors rushed to tranfer funds to the new money market deposit accounts at banks and savings and loan associations.
The transfer of funds to money market accounts is far less complex and risky than the recycling of oil revenues in 1974, but the comparison between the two isn't too far-fetched, and helps underscore the flexibility of the nation's financial system.
Almost overnight, the new accounts have attracted as much money as the money market mutual funds did in five years. Between Dec. 14--when banks and S&Ls first could offer the new accounts--and Feb. 2, a total of $232 billion was put into them, according to the Federal Reserve Board. Another $17 billion was deposited in the related Super NOW accounts.
"And we thought the money market fund industry grew rapidly," said Joyce Healey, senior vice president of New York's Manufacturers Hanover Trust Co., who heads that bank's efforts to corral the new accounts.
Investors withdrew $31.2 billion from the money funds between Dec. 14 and Jan. 26, although it is hard to pinpoint how much of that went to the new bank accounts. Investors also cashed in stocks, bonds, Treasury bills and other investments to put in the bank accounts.
Bankers and regulators agree, however, that the bulk of the funds came from within the banks and savings and loan associations themselves: Depositors diverted dollars into the new money market deposit accounts from passbook and checking accounts, All Savers certificates and maturing $10,000-minimum, six-month certificates of deposit. According to the Federal Reserve, the amount of bank certificates of deposit outstanding shrank by $30.4 billion, between Dec. 14 and Jan. 26. (A Washington snowstorm impeded the Federal Reserve's financial report about the week ended Feb. 2).
But the domestic financial system wasn't even tested by the huge funds transfer, according to banking experts.
The money market funds themselves were most at risk, and they had no difficulty adjusting to the situation. The new deposit accounts, which have no interest ceiling, were designed to enable financial institutions to compete directly with the funds, which for years offered small savers the only opportunity to get high interest rates. The money funds pooled the funds of thousands of investors and bought high-yielding, short-term securities such as the $1 million certificates of deposit sold by commercial banks and commercial paper sold by companies.
As interest rates skyrocketed in the late 1970s and early 1980s, money market funds became a major force in the nation's financial system. Their assets grew to more than $200 billion, much of it money that had been in commercial banks and savings and loan associations. The funds, in effect, lured money from banks and S&Ls that had been costing those financial institutions 5 percent, then "lent" it back to the banks at higher rates (often 15 percent or more) by purchasing bank certificates of deposit.
The money funds prepared themselves well for the onslaught of the new bank accounts, said William Sullivan, vice president and chief money market analyst for the Bank of New York. They met most of the withdrawal demands from the proceeds of the securities that mature each day. (The average money fund has investments with maturities of 39 days, according to Donoghue's Money Fund Report.)
Even when the funds had to sell some assets to come up with cash, they had no trouble disposing of them, because there is a vast market for most of the securities in which the funds invest, and in most cases the value of the securities has increased since the funds purchased them because interest rates have been falling.
"We were fortunate; we were able to meet all our demands from the proceeds of each day's maturities," said Eugene Glaser, who heads the two money market funds run by the brokerage firm Drexel Burnham Lambert Inc.
"We didn't have to sell anything. But even if we would have had to sell, we would have felt confident in doing so," he added.
(Had interest rates been rising after the new accounts were introduced, the value of securities held by money funds might have been declining, which would have increased the possibility of losses by the funds.)
Meanwhile, banks and savings and loan associations find themselves with about $40 billion to $50 billion of new deposits--funds other than those merely transferred from another account.
That is a double-edged sword, according to James Wooden, who analyzes the banking industry for Merrill Lynch Pierce Fenner & Smith, the giant brokerage firm.
Having deposits back in the banking system is good for banks and the economy, he said. But many banks will have problems using the new funds efficiently because loan demand is still weak.
Giant banks like Citicorp or Chase Manhattan can easily use the new funds to replace outstanding CDs. But smaller banks with deposit bases consisting primarily of consumer accounts have fewer uses for the new money.
Wooden said he worries that banks might end up cutting rates on loans sharply. That would put severe pressure on bank profits, he said, especially at a time when the once-stable cost of consumer deposits fluctuates on a daily basis, depending upon what the bank is paying on the money market deposit accounts.