Some details about the money-market fund crisis of 2008

Associated Press, via Yahoo! Finance, has an interesting story on the extent of the crisis faced by money-market funds during the financial crisis. The story quotes analysis done by Moody's on the extent of the chaos during that period. For those not following the story back then, a prestigious and influential money-market fund "broke the buck" during the financial crisis because it held some "bad" Lehman Brothers debt. Money-market funds are thought to be "near-cash" and practically no one investing in them expects to lose money in nominal terms (the only possible losses that investors expect is real losses if inflation ends up being high.) So, it goes without saying, it was a big shock when a major fund lost money.

At least three dozen money-market mutual funds were at risk of failing during the financial crisis, besides one that did end up collapsing, Moody's Investors Service said Tuesday.

The report shows how shaky the nearly $3 trillion money-fund industry was after Lehman Brothers' September 2008 collapse.

Around the time that a soured Lehman investment triggered the demise of the $64 billion Reserve Primary Fund, Moody's says at least 36 other U.S. money funds were also at risk of "breaking the buck" -- failing to ensure clients could get back at least a dollar for each dollar they put in.

But investors avoided losses because at least 20 companies spent billions to prop up their funds, Moody's said. Support included purchasing the soured investments that put the funds at risk, funneling company money directly into the fund, or securing a letter of credit.

Moody's also found 26 European money funds that were endangered. All told, companies with U.S. and European funds that were at risk spent about $12.1 billion, before taxes, to prop them up, Moody's found.


The report also found 146 instances before the crisis where fund companies had to rescue funds to prevent them from breaking the buck.

A researcher with another firm tracking the money-fund industry, Peter Crane of Crane Data, said the $12.1 billion in pretax expenses cited by Moody's as having been spent to prop up funds far overstates the long-term costs. Many fund companies that tried to shield clients from losses by purchasing failed portfolio investments ended up selling those holdings later, sometimes without big losses, Crane noted. Money from those sales could eventually absorb some of the upfront costs to prop up a fund.


Money funds' largely unblemished safety record took its biggest hit when the value of Reserve Primary's assets dipped to 97 cents per share.

The fund disintegrated after announcing that the $785 million it held in Lehman debt had become worthless when the investment bank filed for bankruptcy protection. Institutional clients demanded cash back, and the fund's managers were forced to sell the fund's assets at steep discounts during the market plunge in September 2008.

While nearly all shareholder cash has since been returned, it was the first time individual money fund investors suffered losses since Reserve Primary launched the industry in 1972. The fund's collapse shocked Wall Street and stoked fears of a full-blown economic collapse.
In a hundread years, people will look at an event like this to feel the severity of the recent crisis. Economies contract and companies go bust—even big banks—but I'm sure that a money-market fund losing 3 cents on the dollar would be a shock even to someone living 100 years from now.


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