The failure of Lehman Brothers> will rightly go down as one of the pivotal events of financial history, but it has largely overshadowed another earth-shaking event that remarkable week a year ago one with far more immediate impact on the average investor.
On Tuesday of that week, Sept. 16, 2008, the Reserve Primary Fund, the country s oldest money-market mutual fund, and one of its most prominent, officially broke the buck, meaning its net asset value fell below $1 a share. It was the first time that a money-market mutual fund open to the general public had fallen below a $1 net asset value.
Not only did investors in the allegedly super-safe money-market fund lose money, but many couldn t even get to it. Breaking the buck exacerbated a run on the fund that was already underway and the fund suspended all redemptions that Tuesday. The fund s operators subsequently began liquidating it and have been embroiled in ongoing litigation with the Securities and Exchange Commission. In many ways, the liquidity crisis was worse than the loss, since many people rely on money-market funds for their short-term cash needs.
The failure of a major money-market mutual fund, and the imminent threat that panic would spread throughout the $4 trillion global money fund market, brought the commercial paper market to a screeching halt. Money market funds were the major buyers of commercial paper, which many corporations rely on to meet their short-term funding needs. Had that market collapsed over the longer term, many companies would not have been able to meet their payrolls. The twin specters of investors not able to access their money-market funds and companies not able to fund their day-to-day operations was the abyss into which we were all gazing a year ago this week.
When policy makers, led by then-secretary of the Treasury Hank Paulson and Federal Reserve Chairman Ben Bernanke, were trying to anticipate the reactions to Lehman s failure, they braced for many contingencies but not the failure of a major money-market mutual fund. Lehman s problems were so well known for so long, the reasoning went, that anyone holding Lehman securities would surely be a speculator, not a conservative, safety-oriented money-market fund. Yet the Primary Fund held some $785 million in Lehman debt securities at the time Lehman failed.
Secretary Paulson, with the support of the Fed, acted swiftly and decisively. In one bold stroke, he decided to issue a federal guarantee for all money-market mutual fund deposits. Even some of his Treasury staff members were stunned. After all, they were guaranteeing a $4 trillion market. Even the protection on federally insured bank accounts is capped on a per-depositor basis (and as a result of howls of protest from the banking industry, the FDIC insurance limit was raised to $250,000). And the guarantee removed another cornerstone of moral hazard, the notion that investors must bear the risks of their actions. Although they were perceived as ultra-safe, money funds were an investment product with higher yields than most bank accounts. Yet now investors were being relieved by the government of any risk. In this regard, millions of average Americans, not just Wall Street fat cats, got a bailout.
Whatever the issues at the time, it s now clear that guaranteeing the money-market mutual funds may have been one of the best things and maybe the> best thing that Paulson and Bernanke did that week. It stopped the money fund run in its tracks. The commercial paper market slowly came back to life. Money-market funds have regained their health and are again growing. We edged back from the abyss.
But embedded in the good news is a wake-up call to investors: The government s one-year money-market fund guarantee is set to expire Friday, Sept. 18. We now know that money-market mutual funds aren t risk-free and a certain degree of moral hazard is being reintroduced. Investors in money-market funds need to understand the risks and evaluate whether the slightly higher (or in some cases, lower) returns are worth it, something that few of us ever did before.
This requires some work. To see exactly what holdings were in various money-market mutual funds, I had to go to a fund parent s web site, find the fund, and then locate the fund s quarterly or annual report. In the case of some funds, substantial amounts are held in commercial paper or certificates of deposit in overseas banks. Others, meanwhile, invest mostly, or exclusively, in U.S. Treasurys though there s a price for that safety, since their one-year returns can be less than half a percentage point.
It may be time to reconsider the old-fashioned bank account. While researching this column I ran into an ad for a money-market savings account offered by AIG Bank. The name AIG may still be synonymous with everything that went wrong a year ago, but it s FDIC-insured and yields 1.75%.