The Board of Trustees of the Putnam Funds announced today that it has voted to close the institutional Putnam Prime Money Market Fund, effective as of 5:00 p.m. on September 17, 2008, and distribute all fund assets. Putnam Prime Money Market Fund is offered to institutional clients with a minimum initial investment of $10 million. The Trustees' action was not related to the portfolio's credit quality, but was instead a reaction to marketwide liquidity issues. The fund, like Putnam's other money market funds, has no exposure to securities of Lehman Brothers, Washington Mutual or AIG at the parent-company level. The fund's net asset value calculated on September 16, 2008 was $1.00 per share. On September 17, the fund experienced significant redemption pressure. 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. In the face of these challenges, the Trustees determined to close the fund to ensure equitable treatment of all fund shareholders.
I've had several people ask me if their money market funds are safe. This might be a good time for a brief primer on what a money market fund does (though of course, a better time would have been before we all plowed our money into them).
For consumers, money market funds generally function as a cross between a mutual fund and a bank account. The idea is, you buy shares at a dollar a share. The plan will invest those shares into low-risk* securities, like commercial paper and treasury notes. However, unlike a mutual fund, a money market fund strives to keep its per-share Net Asset Value (NAV) at exactly $1 per share. The idea is that, just like a bank account, every one dollar you put in entitles you to draw exactly one dollar out. Any interest or appreciation on the fund's assets are distributed as income to the shareholders. This is the yield that you see quoted on your bank's prospectus--typically higher than a bank account, but not that much higher.
"Breaking the buck" is what happens when a firms assets are no longer adequate to cover that $1 per-share value. At that point, the fund has to close up and distribute what it has left.
If you have a money market deposit account through your bank, my pet expert assures me that it is insured. However, if you have a money market fund in your brokerage account, those losses are not covered by the SIPC. The Securities Investor Protection Corporation (SIPC) has been described as the brokerage equivalent of the FDIC, which insures your bank account up to $100,000 in the event of a collapse. This is not quite accurate.
When a bank goes down, if you had $10,585 in a checking account, you're supposed to get $10,585 back with the help of the FDIC. When a brokerage folds up, it's supposed to return all your securities and cash to you. Basically, the SIPC makes accounts good if the brokerage runs out of money to pay off its clients. But it doesn't insure you against losses--all it guarantees is that you'll get back the assets (cash and securities) that you had in your account. If AT&T has dropped from $100 to $6, that is not the SIPC's problem. All they guarantee is that they will give you either $6 or a share of AT&T.
The SIPC will make investors whole up to $500,000 worth--but only by replacing assets at current market value, not the original asset value. Nor will they, as far as I can tell, compensate you if your broker's failure leaves you unable to sell a plummeting asset until it is too late.
Thus with a money market fund, the job is to make sure that you get however many shares of the fund you are entitled to. But if your 10,000 shares are now only worth $3,500, it will not give you back the $6,500 you lost.
If your fund is with a big house like Vanguard or Fidelity, this shouldn't worry you too much; even if they've got a lot of Lehman paper, their pockets are deep enough to write a check to cover the loss. And they almost certainly will, because allowing investors to lose money on their money market funds would do terrible damage to the company's reputation. However, if you've got a mutual fund with a smaller house, they might not be able to stump up the money.
That's why spooked investors are rushing to redeem shares in smaller funds, mostly the kind that institutions park their excess cash in (the fund Putnam is closing up had a minimum investment of $10 million). Most money market funds are only required to disclose their holdings once per quarter--and at that, the information is 60 days old by the time its filed. God knows what kind of toxic waste they've accumulated in the meantime. I'm told that a number of institutions have been topping up their mutual funds for months rather than let them break the buck and put the firm in line for investor lawsuits. The fund that failed the other day was apparently one of the unfortunate few that clued in its investors more often.
The problem is not that most of these funds are insolvent--they can't all have bought huge chunks of Lehman paper. The problem is that they're illiquid. If a large number of investors all try to sell out at once, they have to dump large blocs of assets at fire sale prices. That all by itself will make the fund break the buck, even though they were perfectly solvent before everyone asked to have their money back. Putnam suffered just such a bank run; I expect the institution will be kicking in some cash to make investors whole.
This happened even though Putnam owns no Lehman or AIG paper at all. Institutions just became fearful of holding money market shares. I would expect to see more failures/closures over the next few days.
But for most ordinary investors, who bought their funds through a bank or a large brokerage, I would be very surprised if they take a loss on their money market funds. Especially if you've got the money in a fund that invests only in treasuries, as some do. Of course, at the interest rates treasuries are paying right now, you might as well take your money out and tuck it under the floorboards.
It's not impossible, of course, and the first people in line in a bank run are the ones who get all their money back. So you'll have to decide whether you want to risk losing some money, or contributing to an escalating financial crisis.
* Normally
Update: commenter James Shearer, and a friend, point out that technically money market funds don't have to close up when they break the buck. Practically, however, it's been assumed that they would have to because investors would hasten to get their money out, causing the fund to collapse. (We don't know, really, because up until now it's been so rare)
Mr Shearer also notes, of my statement that investors in big funds like Fidelity and Vanguard would probably be all right:
Though even at its low rates, Vanguard's advisory entity probably has some cash, so it's hard to be sure.This is dubious as regards Vanguard which is a nonprofit owned by the funds it manages. The only way they could bail out one of their funds would be by assessing the remaining funds and I doubt they would do that.
Further update: Vanguard's public relations department emails to say "you're correct, Vanguard's mutual structure does not preclude us from maintaining the stability of our money market funds."
""Breaking the buck" is what happens when a firms assets are no longer adequate to cover that $1 per-share value. At that point, the fund has to close up and distribute what it has left."
Actually it doesn't, it can do a reverse stock split to restore the $1 per share value and continue in business.
So for example you have 100 shares and the value per share has dropped to $.99 (for a total value of $99) the fund can do a reverse split (replacing each share with .99 shares) leaving you with 99 shares with a per share value of $1 (leaving the total value $99).
"If your fund is with a big house like Vanguard or Fidelity, this shouldn't worry you too much; even if they've got a lot of Lehman paper, their pockets are deep enough to write a check to cover the loss. ..."
This is dubious as regards Vanguard which is a nonprofit owned by the funds it manages. The only way they could bail out one of their funds would be by assessing the remaining funds and I doubt they would do that.
Ok, that being said - I moved mine. Better to have next semesters college paynment for the kids intact than feel good that I saved the rest of your money.
How is one to know the institution hasn't taken on other commitments using the money market holdings as collateral?
That would be extremely illegal. The bigger worry is that some other investment will take down the firm, leaving the entire entity short, and you'll have to get in line with other creditors.
Back to SIPC and brokerage. Many folks signed securities lending wavers as part of standard account agreements. Has this essentially waived any SIPC claims an account might have? Same goes when margin has been attached to an account?
Any thoughts on the government handcuffs 401k's and 403b's have in place? Investors can't get their money out of what are supposed to be the least risky offerings (money markets) of these programs without incurring essentially a 50% tax penalty. That said, do you think any senator or member of congress would support zero penalties for withdrawals as more of institutions shudder these money markets and list losses?
If your fund is with a big house like Vanguard or Fidelity, this shouldn't worry you too much; even if they've got a lot of Lehman paper, their pockets are deep enough to write a check to cover the loss. And they almost certainly will, because allowing investors to lose money on their money market funds would do terrible damage to the company's reputation.
Megan, this is worth saying over and over and over again. I write on personal finance (for a somewhat lower-profile site than this one) and I have made this point several times to my readers. No, it's not "guaranteed", but the reserves and reputation of Vanguard or Fidelity are good insurance nonetheless -- and really, are we sure the FDIC would be good in the face of a major-bank failure right now anyway?
And re Shearer's comments re Vanguard... I am quite sure they would look to their subadvisors and/or reserve funds of various kinds should an emergency arise. I stand by my comment above.
And re Shearer's comments re Vanguard... I am quite sure they would look to their subadvisors and/or reserve funds of various kinds should an emergency arise. I stand by my comment above.
As a former Vanguard employee, I can say that while I don't know for sure, baring a crisis of epic proportions, they'd do what they had to to keep investors whole re: Money Market Funds. How would they do that? I don't know. I just know that as stated before, they'd come up with a way rather than losing integrity. The money could be made back.
Another reality check is to look at the yield on your fund vs the industry average (I think you can also use either of the large MM funds managed by Fidelity or Vanguard as a pretty good proxy for average). It is pretty hard for a money market fund to beat the averages unless they are taking a heck of a lot more risk. I'm guessing some funds picked up Lehman (or fill in your favorite high risk financial institution name here)to pick up an additional 25 bp, thinking they would close out at the end of the quarter when they report their holdings, so they could report a good yield and help their rankings with none the wiser why.
On Vanguard I think they would argue their yields are competitive due to low costs, so they don't need to stretch their risk to get high returns. Their yields don't look unduly high when you factor in the lower costs. Not saying it can't happen there but others would probably have problems long before them. At least as a holder of a Vanguard MM fund I hope that is true.
The other thing to keep in mind is that the losses seem around the 3% range for the reserve fund. I'm not minizing the surprise/shock to investors on what is suppose to be a super safe investment, nor am I saying it can't get worse than that, it can, but lets also not panic that the losses on these funds will be dot.com like (absence gross negligence or fraud).
Also helps to keep in mind from another comment I read:
1) Dont' Panic
2) If you are going break rule (1), be the first one to do it.
If you have an account with Schwab and trade in and out of stocks .... when your out of stocks and in 'cash' are you actually in a money market swap fund? ... and, how do you not be there if your not in the market? ... I'd rather be in Procter & Gamble than a money market fund at this juncture ... a rush to get out of these funds could push up a nice bull run in the market.
"And re Shearer's comments re Vanguard... I am quite sure they would look to their subadvisors ..."
Their money market funds are managed in house. Look I like Vanguard because of their low fees and own some of their mutual funds. But the very fact that their fees are low gives them less incentive and ability (than say Fidelity) to bail out one of their money market funds since there is no future stream of expected profits to protect.
For the 10 years ending December 2006 their Prime portfolio had an average yield of 3.77% and their Treasury portfolio had an average yield of 3.50%. There is a reason for the difference.
"Vanguard's public relations department emails to say "you're correct, Vanguard's mutual structure does not preclude us from maintaining the stability of our money market funds.""
This just means they can maintain a diversified portfolio of high quality short term paper. It doesn't mean that they have some big pot of money somewhere to cover any mistakes. At least there doesn't seem to be anything in their prospectus to that effect.
James, of course it's not in the prospectus! If it were in the prospectus, it would be a guarantee! I'm sure it's not in Fidelity's, either -- it certainly wasn't when I was employed writing prospectuses for Fidelity many years ago -- but you don't seem to be arguing that point.
(Apologies for the exclamations, but c'mon.)
I'm still comfortable saying that in the event of a buck-break, Vanguard would a) pull out all stops to protect shareholders and b) have recourse to quite a few stops. Apparently their PR department -- after vetting by Vanguard's legal department, I'm sure -- is comfortable with the idea as well.
Large portions of money market fund assets are damaged goods, dodgy or downright fictitious. All the talk about how most of them will probably be alright as long as there isn't a run on them is whistling past the graveyard.. They aren't @^&^# money.
An extremely important concept to grasp as you survey the history of the panic is the 'moneyness' of various types of financial instruments. Various types of credit paper has lost all trace of moneyness. More so their derivatives, ie. credit default swaps.
Get your mind around the fact that what we are seeing is deflation. The economic system cannot exist if there is deflation. It dies. Joe Six Pack doesn't understand how LEH lost XXX billion dollars. He will understand when his money market account is paying 99 cents on the dollar. That's deflation he can belive in my friend.
M2 has been rising robustly, on the back of money market inflows. That is over. Just wait till the M2 shrinkage starts to hit the news. Money market withdrawals are the single biggest systematic threat extant right now.
Keep whistling past that graveyard.
A libertarian cannot believe in a fiat money system. If they try to they are weak minded. They must be advocates of hard money. Money that isn't controlled by the government.
In which case the middle class as we know it wouldn't exist, nor would libertarians. It's a puzzle.
Technically speaking, Vanguard is a for profit company owned by its clients.
When the currency crisis hit S. Korea the people's response was to rally behind the govt. They offered personal gold savings to create liquidity and foreign exchange, did not run on the banks, and otherwise hunkered down in total solidarity with their leadership. That currency crisis was worse than our current situation. Buck up.
Get your mind around the fact that what we are seeing is deflation. The economic system cannot exist if there is deflation. It dies. Joe Six Pack doesn't understand how LEH lost XXX billion dollars. He will understand when his money market account is paying 99 cents on the dollar. That's deflation he can belive in my friend.
So, how safe is a Fidelity FCASH core deposit? It has underlying money market deposits. it has a low yield of 0.11%. And, how safe is the Fidelity FDRXX money market fund?
I made the move today because I wanted to fully protect my cash funds I decided to move them from my Vanguard prime money market account to my online ING Direct savings account. This is not a reflection on Vanguard, because it is the best fund manager in the industry, it is more a risk management move on my part due to all the financial market and institutional turmoil.
Looks like congress will just insure the money market funds under the 401k and 403b plans. Does this come with a requirement for these plans to offer a TIPs vehicle to handle the inflation eventually accompanying this massive commitment?
None of the above comments offer any comfort to me, as Ameriprise, which holds my self managed brokerage account inside a 401K,is withholding my money market dollars (1/2 of them anyway, according to a customer service person I spoke with today) refusing to release. I don't know how much I will get back in the end. Representatives there have told me that they do not know how Vanguard and Fidelity can cover these losses. Funny thing is I did not know I had any money in the Reserve Primary Fund until Ameriprise turned my generic money market notation on the account turned into an actual position in the fund. I certainly hope that they took this move to help me.