Money Market Fund "Breaks the Buck" on Lehman Losses

Money Market Fund Says Customers Could Lose Money
By DIANA B. HENRIQUES
September 16, 2008

In a new sign of market turbulence, managers of a multibillion-dollar money market fund said on Tuesday that customers might lose money in the fund, a type of investment that has long been considered as safe and risk-free as a bank savings account.

The announcement was made by the Primary Fund, which had almost $65 billion in assets at the end of May. It is part of the Reserve Fund, a group whose founder helped invent the money market fund more than 30 years ago. .

The fund said that because the value of some investments had fallen, customers now have only 97 cents for each dollar they had invested.

This is only the second time in history that a money market fund has “broken the buck” — that is, reported a share’s value below a dollar.

This year alone, big banks and fund management companies have pledged more than $10 billion to rescue affiliated money funds that were caught holding mortgage market securities that were deteriorating rapidly in value. As a result, consumers have felt confident in the safety of money funds, and have been moving assets into such funds as markets have grown more turbulent.

The Investment Company Institute, the mutual fund industry’s trade group, issued a statement Tuesday assuring investors that “the fundamental structure of money-market funds remains sound.” It noted, too, that in the only previous case of a fund breaking the buck, investors nevertheless were paid 96 cents on the dollar.

But the Reserve Fund’s announcement may shake investors’ confidence. Moreover, institutional markets that are already under severe stress could be further shaken if this giant fund, and others like it, are forced to sell some less-liquid holdings to meet redemption demands from nervous customers in coming weeks.

The Primary Fund allowed its share price to fall below a dollar “after reviewing the unprecedented market events of the past several days and their impact” on the fund, the company said in a statement.

Specifically, the fund’s management, which boasted as recently as July about its cautious approach to the current crisis, determined that its stake in debt securities issued by Lehman Brothers Holdings, with a face value of $785 million, was essentially worthless, given the investment bank’s filing for bankruptcy protection. As a result, the fund said, its per-share value fell to 97 cents a share.

The fund’s financial records also show that more than half of its portfolio on May 31 consisted of asset-backed commercial paper and notes from a host of issuers besides Lehman, few of them names likely to be familiar to the financial markets.

If these arcane investments had to be sold or cashed out quickly to meet redemptions, it is unclear what prices they would fetch or whether the issuers would be able to return the fund’s money promptly, said Keith Long, of Otter Creek Management, a hedge fund based in Palm Beach, Fla.

The Primary Fund reported that, until further notice, it would delay paying redemptions to customers for up to seven days, as permitted under mutual fund law. That delay will not apply to debit-card transactions, automated clearinghouse transactions or checks written against the assets of the Primary Fund, provided that the transactions do not exceed $10,000 from single or affiliated investors.

The fund is part of the complex run by Bruce R. Bent, who invented the money market fund concept with Henry B. R. Brown in 1970.

Since their inception, money market funds increasingly have been seen by individual investors as a safe harbor in turbulent times. According to industry statistics, the assets of money funds have grown sharply since the credit crisis began to intensify last summer.

But, as prospectuses and regulators make clear, money funds are not legally required to keep their share prices at or above a dollar, or to redeem investors’ shares immediately. Like all regulated mutual funds, their share prices are determined solely by dividing total portfolio assets by the number of shares outstanding, and they have seven days to meet redemption demands.

Those facts would probably surprise most money fund investors, who have come to think of money funds as being “just like cash, just like a checking account,” a fund industry lawyer, Jay Baris, said.

Whenever money funds have run into trouble, they were propped up by parent banks and investment managers that provided the necessary cash. The single exception was in 1994, when one small regional money fund reported a share price below a dollar, according to the Investment Company Institute.

The continuation of this informal bail-out policy “is much-discussed in the fund industry, because funds are so much bigger today,” said Barry P. Barbash, a fund industry lawyer with Wilkie Farr & Gallagher and a former senior mutual fund regulator at the Securities and Exchange Commission.

In the past, regulators tended to focus on banning money funds from buying inappropriate investments in the first place, he said. “But now,” he added, “we’re talking about instruments that were completely appropriate for a money fund when they were purchased. That’s what makes this so much harder.”

Not only are funds bigger, markets are more turbulent. A host of mutual funds have found their portfolios battered by investments in commercial and investments banks that were long considered close to bedrock on Wall Street. Money funds, too, suddenly found that some of their blue chips were tarnishing.

But with individual mutual fund investors showing little sign of panic, most funds have simply ridden out the current turbulence.

However, several industry analysts said on Tuesday that the Reserve Fund’s action came after its Primary Fund had been hit by heavy redemption demands that intensified the impact of the Lehman losses.

“We’re really in uncharted territory here,” said Peter Crane, the president of Crane Data, a fund industry newsletter.