Reserve Primary Fund (Ticker RFIXX), a money market fund with $62 billion in net assets, today wrote off $785 million of debt issued by the now bankrupt Lehman Brothers, reports Christopher Condon for Bloomberg.com.
The Board of Trustees of The Reserve Primary Fund issued a news release today (September 16, 2008). In the release they stated that the $785 million write-off in Lehman Brothers debt brought their net asset value to $0.97 per share. "Effective today and until further notice, the proceeds of redemptions from The Primary Fund will not be transmitted to the redeeming investor for a period of up to seven calendar days after the redemption. The seven-day redemption delay will not apply to debit card transactions, ACH transactions or checks written against the assets of the Primary Fund provided that any such transaction from an investor, individually or in the aggregate, does not exceed $10,000."
The Reserve, according to their website, is "a leading cash management provider for institutions, banks, brokers, advisors, and individual investors." They created the world’s first money market fund in 1970. The Reserve Primary Fund is currently rated AAAm by Standard & Poor’s (that’s their highest rating) and Aaa by Moody’s (also their highest rating).
This is the first time since 1994 that a money-market fund’s net asset value has fallen below the $1 per share level.
Jon Markham warned about this in December 2007. See his article "Your ‘Safe’ Money Isn’t So Safe" at MSN Money. Markham, who was prescient indeed, says:
"Brokerages have pledged to shrink their exposure to SIVs [Structured Investment Vehicles] and tacitly pledged to support money market funds’ values in the event that the mortgage-backed securities in which they are invested go belly-up. But they are not obligated to do so — and in a doomsday scenario, which is not all that hard to imagine, brokerages will have a snowball’s chance in hell of making good on their winks and nods, considering more than $3 trillion is at risk."
What is a money market fund?
A money market fund is a mutual fund that pools investors’ money and invests in short-term, high-grade debt obligations issued by corporations, banks and the U.S. government. The fund manager aims to keep the share price at $1.00. The yield fluctuates over time.
I’ll bet you think of it just like a checking account that pays more interest than you can get at the bank. If you read the prospectus, you would have read something like this: "An investment in a money market fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although the fund seeks to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in the fund." Do you understand what that means? If you have $10,000 in a money market fund, market fluctuations could cause your investment to be worth less than that – maybe $9,900. Maybe $8,500. Did you realize that this is possible?
What happens when a money fund’s yield is less than its management fee? They can only pay out what they take in, minus expenses. Many money funds have been waiving expenses in the current low-interest rate environment. When a money market fund’s share price falls below $1 it is called "breaking the buck."
Not so long ago – in early 2004, Vanguard founder Jack Bogle, referring to "breaking the buck," said: "I don’t think anyone would do that." Why? It would break investors’ trust in the $2.2 trillion industry, prompting many to take their money elsewhere. John Bogle and others like him thought that the fund companies would opt to close out the fund altogether and return money to shareholders rather than risk the net asset value falling below $1. The safety and security of the entire money fund industry would be called into question. Any fund company allowing their money market fund to break the buck would have a public relations nightmare on their hands. That was 2004, now here we are.
Nevertheless, the point is, if you had read and understood the money market funds prospectus, you would have known that losing money in the fund was a possibility. And it could happen.
Note: A money market mutual fund is not the same as a bank money market deposit account. A bank money market deposit account is not a mutual fund – it’s a bank deposit and it is insured by the FDIC. Its yield is whatever the bank chooses to pay.