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Treasury, Fed address money market woes

Record outflows follow market turmoil and 'breaking the buck' by Reserve Fund

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By Sue Asci

September 22, 2008 6:01 am ET

The government took bold steps late last week to avert what might have turned into a run on money market funds.

Reacting to the news that the Reserve Primary Fund (RFIXX) "broke the buck," the closure of a Putnam institutional money market fund and a wave of redemptions, the Department of the Treasury said it will insure the holdings of any eligible publicly offered money market fund.

The funds must pay a fee to participate in the program. The insurance program will be financed with up to $50 billion from the Treasury's Exchange Stabilization Fund, which was created in 1934.

In a separate but supporting move, the Federal Reserve said it will extend loans to commercial banks and bank holding companies at the discount rate to back bank purchases of asset-backed commercial paper from money market funds, which hold about $230 billion in such paper, according to published reports.

The non-recourse loans put the Fed at risk should the value of a bank's collateral fall below its loan amount, as the Fed could not demand that the bank make up the difference.

Last Wednesday, investors pulled $130 billion out of broad-based prime money market funds and put $47 billion into money funds that invest in government securities, according to iMoneyNet, a Westborough, Mass.-based research firm.

"I've never seen this much in outflows," said Connie Bugbee, managing editor at iMoneyNet, which tracks 1,862 funds representing $3.5 trillion in assets.

For the five business days ending last Tuesday, money market assets dropped $89.4 billion or 2.5%, a decline not seen since Sept. 30, 2003, when assets plunged 2.2% on concerns about mutual fund involvement in late trading and market timing.

Driving the flight to safety, in part, was last Tuesday's announcement by The Reserve Management Co. Inc. of New York that the net asset value of The Reserve Primary Fund had fallen to 97 cents. The price reflected the $64 billion fund's ownership of $785 million in debt issued by the bankrupt Lehman Brothers Holdings Inc. of New York.

The announcement marked only the second time in money market history that a fund had slipped below $1 a share in net asset value. In 1994, Denver-based Community Bankers U.S. Government Money Market Fund liquidated as a result of bad derivatives investments, causing a loss to investors of about 4 cents on the dollar.

On Thursday, Reserve said it would not accept new investments in any of its money market funds. Also, it said that redemptions from all Reserve money market funds could take up to seven days, which is permitted by prospectus.

A spokeswoman for Reserve, Ming Hatch, declined to comment on recent developments.

Responding to a cascade of redemptions on Wednesday, Putnam Investments of Boston said Thursday that it had shut its institutional Putnam Prime Money Market Fund (PPMXX). The fund had $12.3 billion in assets on Sept. 16 and closed with a net asset value of $1 per share.

"Serious constraints on liquidity in money market instruments created the risk that in order to process redemptions, the fund would realize losses in selling its portfolio securities," said company spokeswoman Laura McNamara.

Reflecting market pressures, Baltimore-based Legg Mason Inc. on Friday said that it would provide additional capital to three of its money market funds. Legg said it would inject $350 million into Citi Institutional Cash Reserves (CILXX) and $20 million into Western Asset Institutional Money Market Fund (INSXX). It also said it acquired two letters of credit that will provide $260 million in support of CILF U.S. Dollar Liquidity Fund for offshore investors.

Many fund firms posted information and statements on their websites and held conference calls. Fidelity Investments of Boston, the fund family with the largest total assets in money funds, posted a Q & A about its holdings on its website and assured investors that maintaining the $1 a share net asset value of its money market funds is its top priority.

The firm's taxable money funds have no exposure to Lehman, and only "modest" exposure to American International Group Inc. and Merrill Lynch & Co. Inc., both of New York, said spokesman Vin Loporchio.

Federated Investors Inc. held a conference call with more than 1,000 clients last Wednesday and told callers that its money market funds have no exposure to Lehman, AIG or troubled Washington Mutual Inc. of Seattle.

Trading activity in the firm's largest money fund appears to be typical for "this time in September," said Deborah Cunningham, chief investment officer at Pittsburgh, Pa.-based Federated.

During the call, clients asked about potential scenarios, such as what would happen if maturities [of holdings] could not keep pace with withdrawals. "We have a liquidity plan in place," Ms. Cunningham said.

The Vanguard Group Inc. of Malvern, Pa., also put a statement on its website to reassure investors, noting that its money market funds have no exposure to Lehman or AIG.

JPMorgan Funds, a unit of JPMorgan & Chase Co. of New York, held daily conference calls with clients to answer questions.

Columbia Management Group LLC of Boston, the asset management arm of Bank of America Corp. of Charlotte, N.C., posted a letter from its president on its website, noting that its Columbia Cash Reserve Fund has less than 1% exposure to Lehman and no exposure to AIG or Washington Mutual.

"We are actively managing the exposure to the financial sector," said Jon Goldstein, a Bank of America spokesman. Year to date through June 30, Bank of America has supported its money market fund with $760 million.

"Going forward, the bank may provide additional support, but is under no obligation to do so," Mr. Goldstein said.

Since 2007, Bank of America has taken pre-tax charges of $915 million for the support it has given to its money market funds, second behind Credit Suisse Group of Zurich, Switzerland, which took charges of $1.382 billion. During the same time period, other major fund managers that have taken charges for fund support include Legg Mason ($875 million), Morgan Stanley of New York ($402 million) and SunTrust Banks Inc. of Atlanta ($251 million).

The response of several advisers to the turmoil in money market funds was to urge caution.

"I'm telling people to put the money in the lowest-yielding fund they can find, like a government-only money market fund," said Art Grant, president and chief executive of Cadaret Grant & Co. Inc. of Syracuse, N.Y., which manages $1.5 billion in assets and has $20 billion in assets under advisement. "We advise them to move away from the all-purpose fund to a well-defined, conservative money market fund."

Investors should ask about money fund holdings, said Greg Plechner, a principal at Greenbaum & Orecchio Inc. of Old Tappan, N.J., which manages $500 million in assets.

"If they cannot get that information, they need to consider alternatives, like transferring their money to a Treasury money market ac-count," he said.

Managers at Weston, Fla.-based Emerald Asset Advisors LLC made changes last year. "We moved all of these assets into retail U.S. Treasury money funds last November," said Rob Isbitts, president and chief investment officer of the firm, which manages $280 million in assets.

That decision followed the trouble with structured investment vehicles. "We thought this could be a parade of horribles," Mr. Isbitts said.

Other advisers are telling investors to stay put.

Investors should not sell out if they invested properly to start with, said Malcolm Makin, president of the Professional Planning Group of Westerly, R.I., which manages $827 million in assets. "I think money market funds are safe in general," he said.

E-mail Sue Asci at sasci@investmentnews.com.

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