Investors seek out money market funds to find a safe haven for cash. But recent events have shown that these instruments are not without risk. Although most fund managers have manipulated heaven and earth to prevent their money market fund from “breaking the buck”, there are some interesting problems that have come to light in recent years that should cause any investor to ask the question, "how safe are money market funds?"

There is nothing magical about the stable nature of money market funds. It is essentially a bond fund composed of extremely short maturities, with lots of guaranteed government debt (short-term treasuries) mixed in for extra security. The funds typically choose high quality corporate debt, and must comply with new SEC rules that require less than 3% of the fund be invested in lower quality securities.

Those new rules also require shorter maturities. The thinking here is that short maturities carry less risk. For example, GM is very likely to pay off any short term debt incurred in the commercial paper market, typically used for payroll or inventory, because a default would essentially stop the operation of the company. Virtually every large company finances their day-to-day operations with commercial paper.

During the global financial crisis of 2008, the Federal Reserve decided to step in and create a special fund to purchase U.S. commercial paper, after most of the money market funds started to flee the commercial paper market on worries about liquidity and credit quality. What followed was a mess, and included a huge depository exit of investors, the collapse of money market maven Lehman Brothers, and an additional commitment of 50 billion dollars from the Fed to stabilize the run.

If you own a money market mutual fund, you should be concerned.

In the aftermath, there are some important things to consider. Our estimation of credit quality is obsolete and simplistic, and the fund managers know it. From commercial paper to mortgage lending, our lending standards are lax at best, and probably inaccurate. In the weeks leading to bankruptcy, Lehman Brothers had excellent credit quality. Those credit ratings are based on old business metrics that were obsolete long before the issuer cut the check.

The credit markets deteriorated very quickly. For an investor, large scale losses are not the problem; it is access that should be worrisome. There is no doubt that even if the fund were in tatters, the manager would find a cute way to show a 1 dollar NAV on the quarterly statement. How would you be protected in a serious run? It depends on your bank. In a run on money market funds occurred in 2008, it can happen again. This again brings up the question, "how safe are money market funds?" Being able to write a check on your balance might become extremely important if the credit world is imploding and your bank starts dumping phone calls into their voicemail system, or somebody pulls the plug on the internet servers. And a local office might be a godsend if you can walk out with greenbacks while Rome is burning.