Money market mutual funds next to shut shops?

I am not sure how far this crisis will go. After analysing why biggies collapsed (Lehman, AIG), I had mentioned about Fed going broke as well.

The next in line seems to be money market mutual funds (MMMF).

Money market funds are ultra-safe investments, buying interest-bearing securities that mature within a year, and frequently within a week or month. The spectrum of investments runs from certificates of deposit to Treasury securities, from insured notes to asset-backed commercial paper, such as the Lehman notes.

Marketwatch pointed (detailed story here) Reserve Primary Fund, one MMMF “broke the buck”. This is a phrase used in money market mutual funds industry and is for a MMMF that is not able to maintain the $1 NAV on a day.

Unlike ordinary mutual funds, money funds try maintain a constant price of $1. Each day, a fund’s holdings are “marked to market,” meaning the current market value of all holdings is added up, as if they were being sold. Anything above $1 per share basically passes back to the shareholders as interest income.

Anything less than $1 per share has pretty much been considered the death knell for a fund company, which is why, through the years, management firms have stepped in whenever breaking the buck was a real threat.

 

 

This fund has assets worth $ 62.6 billion which included  $ 785 million of short term debt issued by Lehman.  This was just a fraction of the total assets but the fund collapsed as there were huge redemptions.

 

The investors knew of it exposure to Lehman and by Tuesday (16 Sep 2008), the fund size had  declined to 23.6 billion. The investors withdrew USD 40 billion on Monday and Tuesday. At 4 PM the Fund declared it will pay full USD 1 per mutual fund unit for all redemptions before 3 PM. As Lehman became worthless and investors withdrew funds at such massive scale, the NAV became 97 cents. Now it has said redemptions will be honored only after 7 days of application.

 

 

FT Aplhaville points another MMMF – Putnam Prime Money Market Fund has shut operations and is returning money to investors. The surprise is it has not broken the buck but has done so because of redemption pressures. As people demand their money back, a MMMF will have to sell the assets. Despite considered very safe, the markets are such that is safe anymore. This will result in fire sales and lower value for the assets. Fearing this, Putnam MMMF has shut operations and returning money to investors.

Read Putnam’s press release as well. 

 

This is pretty worrying as now MMMFs can simply fall because of redemption pressures. The quality of assets might be strong but that does not matter.  

 

Update:

 

1. Treasury announces a plan to bail out MMMFs as well. It says:

 

President George W. Bush approved the use of existing authorities by Secretary Henry M. Paulson, Jr. to make available as necessary the assets of the Exchange Stabilization Fund for up to $50 billion to guarantee the payment in the circumstances described below.

Maintenance of the standard $1 net asset value for money market mutual funds is important to investors. If the net asset value for a fund falls below $1, this undermines investor confidence. The program provides support to investors in funds that participate in the program and those funds will not “break the buck”.

 

2. Fed announces another measure to help MMMFs. Fed will:

 

extend non-recourse loans at the primary credit rate to U.S. depository institutions and bank holding companies to finance their purchases of high-quality asset-backed commercial paper (ABCP) from money market mutual funds. This should assist money funds that hold such paper in meeting demands for redemptions by investors and foster liquidity in the ABCP markets and broader money markets

 

Non-recourse loans implies Fed will give a loan against a collateral. If the borrower defaults, the lender/issuer can seize the collateral, but the lender’s recovery is limited to the collateral. If the property is insufficient to cover the outstanding loan balance (for example, if real estate prices have dropped), the lender is simply out the difference.

 

So, Fed will give funds against a collateral to these bank holding companies…Now MMMFs have invested in short-term paper (high quality) of these firms….. the MMFs can sell these securities back to the banking company in times of redemption…. banking firms in turn can use the Fed funds to help buy thr securites from MMMFs…..

So Fed provides funds to the various BHCs and BHCs in turn help MMMFs buyback their securities fro MMMFs…..Pretty complicated….I am not sure how Fed can fund each and every activity in financial sector….

With both Fed and Treasury intervening my initial fears about MMMFs failure has been true.