People have worried about protecting their savings and cash since money was invented. Before the introduction of the money-market mutual fund in 1971, the commercial-bank deposit was considered the best way to safeguard the core cash that people need to go about their day-to-day lives.
Everyone knows that money invested in money funds generates better returns than money squirreled away in bank deposits. But just as important: Money in money funds is also very, very safe—inherently much safer than money held in bank deposits.
That's because banks are structurally unstable because the loans that they make are long-term, illiquid and opaque, while the cash deposits entrusted to banks are very short-term, highly liquid and, of course, completely transparent. We know to the penny in real time what every bank owes to its depositors. But neither regulators nor bank creditors have the vaguest idea what the value of a bank's assets might be at a particular point in time. And nobody knows how much of a loss would be realized if a bank tried to sell its assets in fire-sale fashion. This structural instability explains federally sponsored deposit insurance.
(photo credit: Steel Wool)