Some 13 months and seven days ago, we were struck with a certain catastrophe.
Reserve Primary Fund — a money market mutual worth about $64.8bn in September 2008 — broke the buck. In other words, its net asset value fell below $1 a share — something which was never supposed to happen.
Reserve Primary’s buck-breaking promptly started a run on the shadow banking system, culminating in Federal Reserve intervention.
Anyway, we bring you this little flashback because of a certain Moody’s report.
Reserve Primary, according to the agency, wasn’t the only money market fund (MMF) to run into trouble around that time. It looks like at least 62 others were on the verge of breaking the buck, and probably would have done so, had their sponsors not stepped in to support them.
As the analysts, led by Moody’s Henry Shilling, write:
According to our research, 62 funds, including at least 36 funds in the US and an estimated 26 funds in Europe, received financial and balance sheet support from their sponsor or parent company during the financial crisis between August 2007 and December 31, 2009 . . .
During this interval and continuing into 20109, at least 20 firms managing prime funds in the US as well as Europe expended a minimum of about $12.1 billion dollars (pre-tax) to preserve the net asset values of their CNAV funds due to credit losses, credit transitions or liquidity constraints10 . . . On average, this represents a staggering $607 million pre-tax, per firm on average, ranging from a low of $27 million to a high of $2.9 billion reported by one firm. What’s more, at least two fund management firms relied on parent company balance sheets and access to the Federal Reserve window to provide liquidity to meet unexpectedly outsized redemptions and at least two firms consolidated money market fund assets onto their balance sheets . . .
As a side note, it looks like third-party support was a fairly common thing for MMFs. Between 1972 and 2007, Moody’s identifies no fewer than 146 funds that would have broke the buck but for the intervention of their sponsors. For context, around 776 funds have been offered on average since 1980.
But, according to Moody’s, that historical/crisis support could be harder to come by in future:
Notwithstanding the important historical role of sponsor support to the preservation of principal and liquidity, the continuing ability of fund sponsors to financially support their money market funds might be challenged in the intermediate to long-term. As noted in our money market funds 2010 outlook, this may be due to changing industry characteristics, including: (1) Fund sizes are larger with their higher levels of absolute exposure to individual issuer names, (2) Fund securities or counterparties and their industries, across prime as well as tax-free funds, tend to be highly correlated, (3) Funds are investing in shorter dated maturities that are subject to more frequent turnover, (4) There are fewer broker-dealers to buy securities and provide liquidity, and (5) Fund assets are largely sourced to the more volatile institutional investor class.
Moreover, management fees and profit margins are compressed due to historically low interest rates and recoveries on securities defaulted during the financial crisis are lower than historical experience for short-term securities. In turn, these factors serve to push up the financial burden of supporting funds due to adverse credit events. These factors increase substantially the cost to management companies of providing financial support to their funds. The combination of decreasing revenues, due to low interest rates at least in the near-term as well as evolving regulatory developments, and increasing costs of supporting funds due to credit and related losses means that management firms may be less likely to support their funds if they are exposed to significant losses in the future . . .
Bank of America’s Michael Cloherty wrote back in November 2008 that the MMF business model would be at risk if the target Fed funds rate dipped to around 50bps. It’s now at 0.25 per cent.
Once again, some sympathy for the money market funds.
And, err, their investors.
Related links:
‘Breaking the buck’ was close for many – WSJ
Buck-ling money market funds - FT Alphaville, 2009
How low rates break the buck - FT Alphaville, 2008