Money market chaos: reserve fund collapse

On September 16, 2008, when its net asset value (NAV) fell to 0.97 cents per share, the Reserve Primary Fund went bankrupt. This is the first time in investment history that a retail money market fund has failed to maintain a net asset value of $1 per share. These effects have caused shocks across the industry.

Key points

  • The bankruptcy of Lehman Brothers forced the reserve primary fund to go bankrupt in 2008.
  • This marks one of the earliest examples in the history of retail money market funds trading net assets of less than $1.
  • The Reserve Primary Fund only holds 1.5% of its Lehman commercial paper assets, but investors have expressed concerns about the fund’s other holdings.
  • The fund could not meet the redemption requirements and was forced to suspend operations and liquidation.
  • The bankruptcy of the fund means that investors have begun to doubt the safety of money market funds as a safe and liquid investment place.

Anatomy of a crash

Reserve is a New York-based fund manager specializing in money markets, holding $64.8 billion in assets in the Reserve Primary Fund. The fund allocated US$785 million for short-term loans issued by Lehman Brothers. When Lehman Brothers filed for bankruptcy, these loans, known as commercial paper, became worthless, causing the net asset value of the reserve fund to fall below $1.

Although Lehman Brothers’ documents account for only a small portion (less than 1.5%) of the reserve fund’s assets, investors are worried about the value of the fund’s other assets. Worried about the value of the investment, worried investors withdrew their funds from the fund, and the fund’s assets fell by nearly two-thirds in about 24 hours. Due to the inability to meet the redemption requirements, the Reserve Fund will freeze redemptions for up to 7 days. When this was not enough, the fund was forced to suspend operations and begin liquidation.

For a legendary fund, this is a shocking ending and a wake-up call for investors and the financial services industry. It focuses its attention on the credit market, where a full-scale credit collapse is taking place, and commercial paper is at the center of the collapse.

Commercial paper has become a common component of money market funds because they evolved from holding only government bonds (which were once the backbone of money market funds) to increase yields. Although government bonds have the full trust and credit support of the U.S. government, commercial paper is not the case.

Despite the lack of government support, the risk of holding commercial paper has traditionally been considered low because the loan issuance period is less than one year. Although the combination of more attractive rates of return and relatively low risk has attracted many money market funds, the risk has caught up with reserve primary funds.

as a result of

The collapse of the reserve fund is bad news for money market fund providers in every way. The first is the danger of collapse, because reserve funds are not the only money market funds that hold commercial paper. More than a dozen fund companies were forced to step in to provide financial support for their money market funds to avoid bankruptcy.

Even funds that are not affected by bad commercial paper (remember, Lehman Brothers and AIG are just the tip of the iceberg) face possible large-scale redemption requests from investors who do not have a thorough understanding of their investment portfolios.

Fearing such a run on money market funds, the federal government stepped in and issued insurance equivalent to taxpayer funding. According to the money market fund’s temporary guarantee plan, the US Treasury Department assured investors that the value of each money market fund share held by the end of the transaction on September 19, 2008 will remain at $1 per share.

Investors in the reserve fund are not eligible to participate in government-sponsored programs. The fund began to liquidate and made a series of payments, but a year later, many shareholders are still waiting for part of its remaining assets to be returned. When the fund’s management team invoked a clause that allowed them to hold assets to pay for anticipated legal and accounting expenses related to claims resulting from the collapse, the value of those assets was further reduced.

Why is it important?

Reserve funds have a long history and were founded by Bruce Bent, who is often referred to as the “father of the money fund industry.” The failure of this fund was a major blow to the financial services industry and a huge shock to investors.

For thirty years, money market funds have been sold to the public on the premise that they are safe and liquid fund storage places. Almost every 401(k) plan in the United States sells money market funds to investors on the premise that money market funds are classified as cash.

After the disaster of reserve funds, investors began to doubt the safety of money market funds. If “cash” is no longer safe, the question becomes: “Where can investors put their money?” As the stock and bond markets are falling, money market funds cannot maintain their value, and stuffing money into the mattress suddenly becomes Attractive and relevant options for conservative investors.

Although government bailouts are necessary to maintain confidence in the financial system, they also raise another set of questions about the appropriateness of government support. It also encourages lawmakers to raise issues of financial regulation and supervision, and to re-examine the rules surrounding money market funds and the investments they hold. The link between greed and capitalism has also received attention, because Wall Street was backed by Wall Street in another failed investment plan, which paints an unpleasant picture.

Bottom line

The collapse of the reserve fund sends a clear reminder to investors to understand the value of the investments in your portfolio. It also emphasizes the importance of considering the pros and cons of potential investments. Among other issues, it also raises bigger questions, namely the credibility of financial institutions as intermediaries in the financial system and the basic value of legal tender printed and managed by the government. Therefore, P2P financial technology, blockchain and cryptocurrency have emerged.


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