The Buck is Broken

From Bloomberg yesterday:

Sept. 16 (Bloomberg) -- Reserve Primary Fund became the first money-market fund in 14 years to expose investors to losses after writing off $785 million of debt issued by bankrupt Lehman Brothers Holdings Inc.

The fund, whose assets plunged more than 60 percent to $23 billion in the past two days, said the Lehman losses forced the net value of its assets below $1 a share, known as breaking the buck. Reserve Primary, the oldest money fund in the nation, fell to 97 cents a share and redemptions were suspended for as long as seven days.

The only other money- market fund to break the buck was the $82.2 million Community Bankers Mutual Fund in Denver, which liquidated in 1994 because of investments in interest-rate derivatives.

Reserve Primary, run by closely held Reserve Management Corp. in New York, held $785 million in Lehman Brothers commercial paper and medium-term notes. The fund's board revalued the Lehman holdings as worthless effective 4 p.m. New York time, the company said today in a statement.

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.

Money-market funds, which are regulated in the U.S. by the Securities and Exchange Commission, strive to preserve a $1 a share net asset value, meaning that investors can always get back their principal, as well as interest earned by the fund on its investments. 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.

U.S. money-market mutual-fund assets were $3.58 trillion as of Sept. 10, just below their peak of $3.59 trillion set a week earlier, according to the Investment Company Institute, a Washington-based trade group.

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Update #5
03:30 pm EST 09/17/2008: Three-month Treasury bills are trading to yield 0.01% (the lowest yield ever?), in an unprecedented flight to quality and gold closed at $850.50 (Comex/NYMEX) up $70/oz., and up another $20/oz. to $870.50 in electronic trading.

The money market fund buck has been broken again, this time by The Reserve funds, the inventor in 1970 of modern-day money market funds. But can it be restored? And if other money funds begin imposing withdrawal/redemption restrictions, then what? These are the $3.6 trillion questions.

A massive liquidity panic, for one. If a few big funds begin prohibiting withdrawals, or bouncing checks written against balances, or restricting exchanges into safer, all-Treasury/Agency MMFs, an unprecedented run on balances will ensue as anxious shareholders scramble to redeem shares and wire-transfer proceeds to banks.

Anyone with a shareholder interest in a general purpose money market fund should re-read the above story about Reserve Primary Fund falling below the expected $1.00/share threshold as a result of its write-offs of $785 million of Lehman bonds held by the fund. Reserve Funds does not have a "deep pockets" parent company to support it, and could not or would not borrow to make the Reserve Primary Fund, and shareholders, whole.

Evergreen Investment Management, however, has avoided breaking the buck by obtaining nearly $500 million from parent company Wachovia Corp. (which has mortgage and credit-related issues of its own) following a write-off of $494 million of Lehman debt.

On Friday 9/12 the Reserve Primary Fund held $64 billion in assets. Following Lehman's bankruptcy Monday, the fund experienced a "run" of liquidations totalling $40 billion. As such, the fund, down to $23 billion in TWO days, has suspended withdrawals, and the Lehman impact has reduced the net asset value of the fund to $.97. Withdrawals now have been suspended for 7 days, but the suspension is likely to be extended, perhaps indefinitely, as additional distributions will force sales of bonds at losses which will compound the loss to investors.

Frankly, this is a worst case scenario, as this could cause a "run" on all general MMFs, which, surprisingly, are far more illiquid than one would think because the model was to chase high yielding securities (meaning longer term duration/maturity) to get higher advertised yields, and the models were based on a certain percentage of assets kept necessarily liquid to meet an expected amount of daily distributions.

The models DO NOT account for a "run" on the fund, and, as you would expect, the greater the run, the more illiquid junk is left in the fund, so that when they finally suspend distributions, it likely means distributions may be suspended for a long time as further liquidations of the portfolio would be at big losses.

For the first time in 14 years a "retail" fund has broken the buck. (Although last year Bank of America closed an institutional fund at under $1.00). If there is a flight to quality, a move to Treasury only funds (and it would appear there is a Treasury buying binge today), there may be many general purpose MMFs that suspend withdrawals which could be catastrophic in terms of inducing panic and shutting down consumer spending. This isn't getting a lot of media play yet, but it might in the next couple weeks if the runs begin.

Another fund group, Evergreen Investment Management, has obtained nearly $500 million of support from its parent company, Wachovia Corp., to protect three money market funds affected by losses from Lehman, or Evergreen also would have "broken the buck." A critical issue, of course, is to what extent can fund companies, or their corporate parents, fund losses to make shareholders whole. In the case of Wachovia, which has financial issues of its own related to mortgages and loans, it begs an important question regarding the "depth" of its pockets. Again, any redemption "run" on a fund makes it more likely it will require a suspension of withdrawals and an NAV below $1.00.

This is not a drill...Investors who have any $$$ personally in a general purpose MMF should exchange it immediately to a Treasury/Agency Only fund, or risk withdrawal suspensions and below-$1.00 NAVs.