Money Market Funds Run Risk: Will Floating Net Asset Value Fix the Problem?

Abstract:     
Money market funds (“MMFs”) were at ground zero of the financial crisis. Lehman Brother failed on Monday, September 15. One day later, an important money market fund, the Reserve Primary Fund, “broke the buck” because of its holdings of Lehman short-term debt, even though these holdings amounted to only 1.2 percent of the Reserve Primary Fund’s portfolio, well below the five percent single-issuer maximum of the SEC’s rules. Immediately thereafter, investors – led by institutional investors -- began to withdraw from other “prime” money market funds. During “Lehman Week” these withdrawals -- call it a run -- amounted to approximately $300 billion, approximately 15 percent of prime money market fund assets. Various other funds almost broke the buck, rescued by interventions from their many money market fund sponsors. The problem was not the serial bankruptcy of other issuers of money market instruments, but rather the pressure of risk-fleeing investors who wanted to switch to Treasury securities or cash. Their redemptions exhausted the funds’ cash reserves. As redemption requests accelerated and as the short term credit market froze, funds faced the prospect of selling assets at fire sale prices. The realization of such shortfalls would have meant below-$1 NAV at many funds. Indeed, the ultimate $0.97 valuation in the Reserve Primary Fund liquidation – greater than the $0.012 percent loss on Lehman –reflected this phenomenon.

Number of Pages in PDF File: 28

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