A major shoe in the financial industry has just fallen that may have far reaching impact for every day Americans. The Sacred $1.00 share value for money funds has just been breached. This is being reported by Bloomberg News and has the potential to rile the markets even more than they already are.
Sept. 16 (Bloomberg) -- Reserve Primary Fund, a money-market mutual fund with $64.8 billion in assets as of Aug. 31, fell below $1 a share in net asset value because of losses on debt issued by Lehman Brothers Holdings Inc.
Money Market funds are a staple of the financial industry and are the place where most people park their funds when they are looking for a safe return. These funds are routinely considered to be the same as cash. That is to say that you can get to your money at anytime without penalty and without delay.
Update 1Thanks for the Rec list...never been here before.
The fact that Reserve Primary fund fell below the sacred $1.00 redemption price could have far reaching implications for the entire financial sector. Remember money funds are nearly ubiquitous throughout the entire financial sector and they are used for everything from corporate cash management to a parking place for un-invested funds of a pensioner. These funds sole raison d etre is to provide liquidity and safety for investors.
Money funds are regulated in the U.S. by the Securities and Exchange Commission and are considered the safest investments outside insured bank accounts and government debt. They are required to hold debt that matures in 13 months or less, with a weighted average maturity of 90 days or less. The securities must have top short-term corporate debt ratings.
The Reserve Primary fund will delay paying liquidations up to seven days on requests for funds that were being made after 3:00 pm EST today.
It will be interesting to see if this causes a ripple or a wave throughout the financial system.
`This is uncharted territory,'' said Peter Crane, president of Crane Data LLC in Westborough, Massachusetts, which tracks money-market funds. ``That's certainly a stunner.''
A stunner to say the least.
More from Bloomberg...
Unable to Prop Up Fund
Spokeswoman Ming Lee Hatch said she couldn't immediately comment on whether the company planned to secure credit to support the fund or wind it down.
Carl Lantz, an interest-rate strategist in New York at Credit Suisse Securities USA, said the fund's failure ``exacerbates some of the flight-to-quality into Treasuries.''
Crane said Reserve Management probably was unable to prop up the fund before halting redemptions because it lacked the backing of a large institutional owner.
``Reserve just didn't have the deep pockets to buy troubled securities out,'' he said.
Boston-based Evergreen Investment Management Co. said yesterday it had secured support from Wachovia Corp., its parent, to protect three money-market funds from losses linked to debt issued by Lehman. The funds' Lehman holdings totaled $494 million.
Update 2—There have been a lot of requests asking to further describe money market funds. For those of you who are in the financial services industry I am going to ask a bit of indulgence. I am not going to describe all of the various Regulatory Statutes (e.g. Reg T ,Reg D etc.) in giving this brief description. A little background about me: I am not currently in the Financial Services industry but I was for a really long time. I was a Registered Securities Principal, and a Registered Options Principal. I currently am in the text message marketing industry and having a lot of fun. My business partners and I were the text messaging firm behind Hillary Clinton’s text messaging campaign...but I digress (and that is a whole other diary and much more interesting) Now let’s get down to bidness as they say in my fair state...
Money Market funds...most everyone who has money uses one. Few people know what is really in them. Money Market Funds are a mutual fund of assets, analogous to a stock mutual fund. Unlike a stock mutual fund money fund managers are required to keep their funds invested in highly liquid, highly rated short term securities. People who invest in money market funds do so as a place to park short term money which should be treated as cash. Unlike a CD (certificate of deposit) there is no penalty for early withdrawal and there is no time frame that you are required to keep your money invested in the fund.
Money Market Funds come in a variety of flavors. Some invest in short term tax free municipal securities so that any interest that they pay is tax free. Others invest only in government securities (think T-bills) and pay a commensurately lower rate of return.
Nearly every brokerage firm or bank provides a money market fund for their clients to place their money. When dividends or interest payments are paid to a client from their other investments in their account, these funds are typically “swept “ automatically into a money market fund (because as we all know idle money is the devil’s workshop) where they draw a nominal amount of interest while they are waiting to be redeployed or withdrawn. All of the funds that are described here are purchased for a dollar a share by the investing public (ma, pa, your 401 cash fund) and redeemed for a dollar per share. They are managed in a way that always allows for immediate redemptions. There is always money coming in to the money market account and money going out of the account. It is my opinion that one of the reasons that money funds have not yet reached a crisis is because of this. In other words although their underlying assets were being eroded, there has been enough cash coming into the funds from the public to handle the redemptions. A Ponzi scheme of sorts. This changed today. The enormous erosion in capital caused by the Lehman debacle could not be swept under the rug. Hence the delay in redemptions and the .97 price.
Busting the Buck or Breaking the Buck—This is the apocalyptic term used to describe a money market fund that does not pay the dollar redemption. As is pointed out elsewhere in the comments there is nothing illegal about this and the risk of this happening is fully disclosed in the prospectus that accompanies the fund. According to the New York Times and the Investment Company Institute this is only the second time in history that a money market fund has “broken the buck”.Money market funds are not insured by the FDIC, nor or they insured by the SIPC(or SPIC if you John McCain, he never did get that right today)
Net Asset Value—This is the price given that reflects the value of all of the underlying funds that go to make up your money market fund. In other words If I have ABC bond whose value is 1000.00 and I have a 1000 shares outstanding then the NAV is 1.00 per share. If the underlying asset erodes to 900.00 and you have a thousand shares out then you NAV is .90 per share. But as we used to jokingly say "don't confuse short term losses with with long term erosion of you investment capital."
I hope this sheds a little more light on the subject. I will try to answer any questions in the comments section.