Home Economic Trends Higher Interest Rates Drive Wealthy Americans to Money Market Funds

Higher Interest Rates Drive Wealthy Americans to Money Market Funds

Over the past month, American savers have been increasingly concerned about the safety of their savings accounts and the low-interest rates they receive. This has led to wealthy Americans moving their money to larger banks and showing a growing interest in money market funds.

Wealthy Americans, worried about the safety of their savings, have opted to deposit their money in larger banks like Wells Fargo and Bank of America. They believe that the government will always bail out these institutions in case of trouble. In the week surrounding the collapse of Silicon Valley Bank, the largest banks gained about $120 billion in deposits, while small banks lost approximately $108 billion, according to figures from the Federal Reserve.

Despite the shift towards larger banks, interest rates offered by these institutions remain low. For instance, Bank of America and Chase provide interest rates as low as 0.01% on their savings accounts. With the average interest rate on savings in the U.S. at around 0.5% and persistently high inflation, savers are searching for alternatives to boost their returns.

Short-term government bonds offer higher interest rates, around 5% for depositors who invest their money with the government for a few months. Money market funds are the easiest way to take advantage of this, as they invest in short-term, low-risk debt and enable investors to access their money quickly. In February, inflows to money market funds were high at $52 billion, spurred by an aggressive advertising campaign promising interest rates of up to 4.5% annually.

The panic surrounding smaller banks, such as Silicon Valley Bank, Signature, and First Republic, intensified this trend in March. Analysts estimate that approximately $300 billion was added to money market funds in March, bringing the total to about $5,300 billion.

This shift from savings accounts to money market funds has put banks in a difficult position. In the past, when interest rates were historically low, many financial institutions felt compelled to lend their money for longer periods in search of yield. This resulted in more long-term, fixed-rate mortgages and, in the case of Silicon Valley Bank, investments in long-term government bonds. Banks must increase their interest margins significantly before offering customers higher interest rates.

Banking lobbyists argue that the shift from savings accounts to money market funds is detrimental to the U.S. economy. While bank savings are typically used for loans to businesses and households, stimulating the economy, money market funds do not invest in the same way. They traditionally invest in short-term debt securities of large corporations and government bonds, indirectly returning the money to the real economy.

However, as reported by The Economist last week, this is happening less frequently. An estimated $2,300 billion raised by money market funds is deposited directly with the Federal Reserve in the form of reverse repos. This means that the money is not being used to finance economic activity, which could eventually lead to higher interest rates for homebuyers.

U.S. Treasury Secretary Janet Yellen expressed concern about the risks posed by money market funds to financial stability this week. She highlighted that these funds could exacerbate stress during moments of great panic in the markets, such as in the spring of 2020 amid the coronavirus pandemic. Yellen advocates for stricter capital requirements for these funds, making them more like regular banks.

The shift of savings to large banks and money market funds, driven by concerns about safety and low-interest rates, affects both the banking sector and the U.S. economy. Banks struggle to offer competitive interest rates, while the economy may miss out on much-needed investment. Regulators are pushing for tighter regulations to limit the risks of money market funds and ensure financial stability. Clearly, changes are needed to strike a healthy balance between savers’ needs and their impact on the economy.