Investors began a run on The Reserve's Primary Fund last Monday when Lehman's bankruptcy news made them fearful about the money market funds' $785 million exposure to the investment bank's previously blue-chip commercial paper and medium-term notes that had fallen to zero value.
On Tuesday, the oldest money market fund in the U.S. and previously one of the largest, announced the shocking news that it broke the buck, falling to 97 cents on the dollar.
Primary Fund's assets went into a freefall, declining from $62.6 billion at the start of the week to just under $10 million on Thursday, according to Crane Data. It is the second money market fund in the money market fund industry's 37-year history to ever fall below its $1 per share net asset value.
In the last week through Wednesday, assets in the $3.5 trillion money market fund industry tumbled more than $140 billion, according to Crane Data. It is one of the biggest weekly outflows ever, with The Reserve accounting for almost $60 billion of the loss.
Fund giants rushed to reassure investors that their money market funds had little or no exposure to Lehman, AIG and Washington Mutual and remained sound investments with closely protected $1 NAVs that they would shore up if necessary.
Observers said that unlike large fund houses like Fidelity, Evergreen and Vanguard, which can readily bail out their money market funds with other cash reserves, The Reserve is a much smaller company and was unprepared.
The Investment Company Institute reminded investors that although money funds are not guaranteed, it is "extremely rare" for them to fall below $1 a share. Money market funds, the ICI said, offer "security, liquidity and diversification under stringent and effective regulation. The fundamental structure of money market funds remains sound."
Experts stressed that they don't foresee a wholesale run on money market funds. Rather, they expect the failure to be contained just to the Primary Fund, which is expected to liquidate. The future of The Reserve, however, remains in question, although Peter Crane, principal of Crane Data, believes the company "has a sizable presence in the FDIC-insured sweep sector, and that segment doesn't have to worry about a run because it's all FDIC insured. So, it's possible they could retreat into the bank sweep segment, bide their time and try and make a comeback in money market funds."
Investors in the Primary Fund have, essentially, given up a year's worth of interest, said Don Phillips, managing director of Morningstar. "It's an unpleasant misfortune, but it's survivable."
On the other hand, the failure is a "huge blow to [The Reserve's] reputation," Phillips said. "Ultimately, your most valuable asset is your brand and your reputation, and if you've tarnished that, you've done extraordinary damage to the franchise."
Crane called the event "uncharted territory" and said he was stunned.
A spokeswoman for The Reserve declined comment on the status of the fund and the firm.
Meanwhile, investors are stampeding out of higher-yielding money market funds invested in corporate paper into those with Treasury and government debt, iMoneyNet data shows. In the week ended Sept. 16, investors pulled $119.2 billion out of prime taxable money market funds and invested $36.7 billion in government taxable money market funds.
Previously, the only other money market fund to lose value was Community Bankers Mutual Fund's U.S. Government Money Market Fund, a small regional fund that liquidated at 96 cents per net asset value in 1994.
That was when the Federal Reserve made a series of interest rate hikes that caused exotic derivatives, including inverse floaters highly sensitive to interest rates, to sharply drop in value.
In the past 13 months, 20 money market fund investment advisors have spent more than $10 billion to prop up money market funds, to maintain investors' faith in the products, considered as safe as federally insured bank accounts.
In November, Bank of America's Columbia Funds unit came to its money market funds' aid due to subprime exposure in structured investment vehicles (SIV). BoA expected to spend up to $600 million to support its funds.
Credit Suisse's SIV exposure in its money market funds has cost it $125 million. Wachovia has bought $40 million of distressed debt from its Evergreen money market fund, and Legg Mason invested $100 million in one of its money market funds in October and subsequently procured $238 million in credit to support two others. Likewise, SEI Investments and Sun Trust Banks secured credit in the event they need to support their money market funds.
"It's a no-brainer to spend a few million dollars on troubled securities or lose their entire mutual fund franchise that is making them billions of dollars," Crane said. "Anyone who is running a big mutual fund has more than their money fund-they have their reputation on the line."
According to industry insiders, other fund companies approached the Securities and Exchange Commission to ask how to handle SIV exposure in their money market funds.
BoA analyst Michael Hecht estimated that 5% of money market fund assets are in SIV securities. Still, few industry experts believed that any money market fund would break the buck.
What happened to The Reserve, actually, was not a direct investment in an SIV security but in an investment house that, in turn, had placed an outsized gamble on structured derivatives.
As a result, money market fund giants such as Fidelity went out of their way last week to distance themselves from the news and unequivocally reassure investors that their products are safe and sound. Fidelity's taxable money market funds don't have exposure to Lehman but small holdings in two AIG subsidiaries.
Likewise, American Century, Charles Schwab, Deutsche Bank, Federated Investors, Invesco, Janus, Legg Mason, OppenheimerFunds and Wells Fargo all assured investors that their money market funds are not invested in AIG or Lehman. Some, such as Janus, Oppenheimer and Invesco, began disclosing holdings daily to calm investors. Vanguard noted that its money market funds are invested in the highest-grade U.S. Treasury and agency securities. Wachovia revealed said that three of its Evergreen funds have exposure to Lehman, but that it would step in to support the funds' value if necessary.
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