Lehman, Money Market Funds, and the Government Guarantee Controversy

Before this week, most people probably thought of money market funds as ultra-safe places to park cash.

While money market mutual funds aren't FDIC insured like money market accounts at banks, they can only invest in "safe", short-term commercial paper with an average maturity of 90 days.

The funds work to keep their value per share at a constant $1. "Breaking the buck", or having a loss, was something avoided at all costs. If, on occasion, a paper dropped slightly in value, the fund's holding company would buy it from its fund at par.

In return for this safety of principle, investors willingly accepted yields lower than stocks or bonds.

Now, in the wake of Lehman's collapse, one of the original pioneers of money market funds, Reserve Management, wouldn't (or couldn't) buy back its Primary Fund's investment in Lehman paper.

Instead, the Primary Fund wrote off $785 million in Lehman debt, and its value per share dropped to 97 cents.

It became the first money market fund to "break the buck" in 14 years, and shareholders withdrew 60% of the assets in 2 days. The fund since delayed investor redemptions by 7 days.

Even though money markets remain one of he safest investments, and most of the money market fund companies (such as Vanguard, Fidelity, Merrill Lynch, or Schwab) have many times the resources of Reserve Management, investors started to become worried about money market funds.

On Thursday, Putnam Investments closed its $12 billion Prime Money Market Fund after its institutional clients pulled their money out.

On Friday, to calm the markets, the Treasury took the unusual step of temporarily guaranteeing money market funds against losses up to $50 billion.

Needless to say, the American Bankers Association is very unhappy. They saw their FDIC coverage as a competitive advantage for their money market accounts vs. money market funds.