|Lehman's collapse almost brought down the money-market industry
By Sam Mamudi, MarketWatch
NEW YORK (MarketWatch) -- As the threat of a Lehman Brothers bankruptcy grew
last September, many money-market fund managers were wary but not worried.
Their industry had quietly grown over the past generation to become a major
rival to the banking system, with $3.5 trillion in assets. It had weathered
crises such as the collapse of Baring Plc, the Asian currency mess of the
late 1990s and the fall of hedge fund giant Long-Term Capital Management.
Though some managers were talking to their boards and their staff, there
wasn't a feeling of impending disaster.
But all that changed in the late afternoon of Sept. 16, the day after Lehman
actually went down. Reserve Primary Fund -- the oldest and fifth-largest
fund in the business -- said it had about $785 million in Lehman debt that
was now worthless and as a result it would price its shares at 97 cents.
The impact of the first major retail money-market fund to fall below $1 a
share -- to actually lose money for its investors -- was immense. In the two
days after Reserve Primary's announcement, roughly 22% of all assets in
institutional prime money-market funds -- those that invest in corporate
debt -- were pulled out by panicked investors.
As Lehman's fall spread fear throughout the financial system, money-market
fund managers were squeezed on both sides: investors demanding their money
and frozen credit markets where no one was buying.
"Countless other money-market funds were poised to break the buck," said
Peter Crane, president of Crane Data. "The mini-run would have spread to all
It was a pull-out unprecedented in scale. In the space of just two days --
Sept. 17 and Sept. 18 -- $210 billion was redeemed from institutional prime
money-market funds. Overall the money-market fund industry saw roughly 7% of
its total assets redeemed in those two days. While some of that was invested
back into government money funds, the industry lost almost 4% of its assets
in 48 hours, according to data from iMoneyNet.
Even managers at funds with portfolios considered safe from the crisis were
struggling with the market -- because there were no buyers, pricing the
assets in some cases could have meant breaking the buck. In such cases,
managers talked to their boards to explain when they didn't do daily pricing
for their funds.
"It was a shock in that the people who keep the machine going -- the
broker-dealers -- suddenly weren't there to keep things going," said Mira
Stevovich, manager of Ivy Money Market Fund and Waddell & Reed Advisors Cash
Management. "You weren't sure when re-investing that there'd be anyone
behind the securities to make a market if you had to sell."
"There was a lot of fear, and no one knew what was going to happen," added
Even without federal bank insurance, money funds had ballooned in the past
several years as alternatives to holding cash. They often offered better
interest rates than bank deposits, which were insured by the federal
government up to $100,000 at the time (now $250,000). The sudden prospect of
investors losing their savings following the Lehman collapse caused the run,
but because it was mostly in electronic transactions, it didn't summon
visions of anxious crowds banging on bank doors during the Great Depression.
For many, however, the fear was just as palpable.
"There was a concern that if something wasn't in place to regain investor
confidence, after four or five days [the high redemption rate] would cause
problems," said Debbie Cunningham, head of money-market funds at Federated
Investors Inc. . "Selling into the market [to meet redemptions] was already
a problem -- there was no liquidity."
The panic was averted only after the Treasury Department on Sept. 19 stepped
in and announced it would backstop money-fund assets, in a series of
measures that slowly restored investor confidence. But industry officials
are under no illusions about what might have happened.
A year of trouble
In reacting to that week's panic, the industry was both helped and hindered
by its experiences over the previous 12 months. Troubles in the asset-backed
securities market and exposure to special investment vehicles had hit
money-market funds from late 2007 and into 2008.
A MarketWatch study conducted at the time found that more than a dozen funds
had looked to parent companies or other sources of credit to ensure they
didn't break the buck. At least 20 had sought regulatory approval for
support if needed.
But the fact that the funds had come through such a choppy period unscathed
meant that even though some funds were known to hold Lehman paper, few
expected a fund to go under.
"We'd gone through a series of problems leading up to Lehman," said David
Glocke, who oversees Vanguard Group's taxable money-market funds and also
manages its Treasury and Admiral Treasury funds. The funds didn't hold any
"Watching from the outside, we were completely shocked," when Reserve
Primary broke the buck, he added.
The shock was probably biggest among investors. At roughly $3.5 trillion,
the money-market fund industry had grown by $1.5 trillion in the previous
two years and much of that money, said Crane, likely came from investors
fleeing other troubled assets, such as SIVs and auction-rate securities. At
the first sign of trouble in money-market funds, these investors were likely
to bolt once again.
"It wasn't Lehman that killed Reserve Primary Fund, it was the run," said
And fleeing investors caused the effective collapse of another fund, Putnam
Prime Money Market Fund. Putnam closed the fund on Sept. 17 after it came
under heavy redemption pressure -- investors cashing out created a liquidity
squeeze that could only have been met by selling assets below par and thus
breaking the buck. Putnam later sold the fund's assets to Federated, where
it was merged into Federated Prime Obligations Fund .
The Reserve had previously valued its Lehman paper at par, but then suddenly
announced it was valuing the assets at zero, causing the panic.
While many investors are still waiting to get their cash out of Reserve
Primary, the firm said in late August that it values the Lehman debt at
about 17 cents on the dollar and "shareholders could possibly receive up to
99 cents per share."
Reserve Primary's basic problem was, of course, that it held Lehman paper on
Sept. 15. All the managers who spoke to MarketWatch said they had no Lehman
exposure and many said they had during the previous year's troubles been
heading more and more into shorter-duration debt as well as Treasurys and
When the Lehman crisis hit, many managers said they doubled their holdings
of debt with seven days or less to maturity, for instance, up from 15% of a
portfolio to 30%.
"One of the strengths of money-market funds is the ability to retool and
adapt to the market conditions quickly," said Joe Benevento, manager of the
DWS money market series of institutional funds.
Dealing with a crisis
But despite these efforts, even the most conservative managers found
themselves on high alert.
"There was a mismatch that lasted over the course of a few days due to the
seizing up of the market and not having the liquidity to meet demands," said
The head of one of the largest money-market fund lines, who declined to be
named because of the delicate nature of last year's events, said his fund
managers, fearing the worst for Lehman, met with the funds' board during the
weekend of Sept. 13 and Sept. 14 to apprise the board of the funds' status,
none of which had Lehman debt. The funds had also been pulling in their
average maturity and credit risk levels.
The group head added that conference calls with sales staff around the
country were also held during the weekend to provide them with talking
points to deliver to worried clients.
Federated's Cunningham said that had the investor panic lasted, Federated
had a "bevy" of resources, both internal and external, to maintain
liquidity, but that the firm "came closer than we ever thought possible" to
using those measures.
"You always talk about contingency planning in meetings, and then all of a
sudden you find yourself in a situation where you could have to use that
planning," she said.
The worst of the crisis passed on Friday Sept. 19, when Treasury said it
would insure all money-market funds that pay a fee -- the entire industry
eventually joined the program. At the same time, the Federal Reserve said it
would buy agency discount notes from primary dealers, acting as a backstop
when and if money-market funds wanted to sell their assets.
"The [Fed program] was one of the key things done to provide liquidity,"
Cunningham agreed, saying the program was a "great solution." Coupled with
the insurance plan, due to expire on Sept. 18, the two measures were "enough
for everyone to step back and take a breather," she said.
Lower yields more safety
One year later, and the money-market fund industry is roughly back to where
it was just before Lehman collapsed, standing at about $3.5 trillion in
assets and serving as a refuge for those on the sidelines.
But last year's experience prompted government action on two fronts: from
the Obama administration and the Securities and Exchange Commission.
The administration's recommendations are still vague and won't be clear
until the financial reform package is unveiled on Sept. 15.
The SEC's proposals were published at the end of June. The plan calls for
better credit quality, shorter maturities and more disclosure.
"The proposals offer a greater level of protection for fund investors," said
Vanguard's Glocke. "The rules now are for credit events, not liquidity
Among the proposals are requirements for certain levels of assets that must
be held in cash, Treasurys or holdings that can be cashed within one day,
and limiting the maximum weighted average maturity of a fund's portfolio to
60 days, from the current 90 days.
The SEC estimates its proposed changes would lower yields by between 0.02 to
0.04 percentage points. In a comment letter to the agency, Fidelity
Investments said the potential yield reduction could be between 0.19 to 0.43
percentage points for institutional funds and 0.14 to 0.31 point for retail
Robert Deutsch, head of the global cash business at J.P. Morgan Funds,
estimated the fall in yields would on average be between 0.05 and 0.1
"You're giving up that yield to get extra safeguards," said Deutsch. "It
seems like a good trade-off."
Deutsch said he didn't think the lower yields would put off investors. After
last year's panic, "there's been a big shift in how investors think, moving
away from yield-chasing funds."
Reserve Primary was among the highest-yielding funds in the industry.
Despite the reform efforts, some say that last year's events may simply have
to be seen as a once-in-a-lifetime event.
"The SEC may be able to prevent one or two dominos from falling, but nothing
could have prevented the complex series of events that led to what happened
[last September]," said Crane.