Some anniversaries just aren't meant to be celebrated. A year after the Reserve Primary Fund broke the buck and ignited industrywide panic, the federal government's profitable insurance plan for money market funds is set to come to an unceremonious end on Friday.
But as investors look to bury memories of the wreckage left behind by the disastrous month of September 2008, analysts are using the expiration of the program as an opportunity to reflect on the state of the money market as the grip of government intervention begins to loosen.What they see, for the most part, is an industry that has spent the past 12 months on an unsteady road to recovery and that is once again ready to support itself. "I think the money market fund industry really needs to stand on its own feet," says Jeff Tjornehoj, Lipper's research manager for the United States and Canada.
In some ways, the industry will pick up right where it left off before the implementation of the insurance program. According to the most recent tally, investors have $3.54 trillion in money market funds, an amount comparable to the $3.46 trillion invested in them when the program was instituted to curb what was quickly becoming a mass exodus.
The outflow was triggered when the Reserve Primary Fund, which at the time had $62 billion in assets, dipped below $1 per share on Sept. 16, 2008, challenging the traditional notion that such funds couldn't lose money. The insurance initiative was announced three days later, on September 19. The Treasury Department offered funds the chance to pay for the federal government to back their holdings—with some caveats—against up to $50 billion in losses. In other words, if participating funds broke the buck, investors would get their money back. "It was a lifesaver for money market funds and likely prevented extensive damage to the broader economy," says Peter Crane, president and chief executive of the money market tracking company Crane Data. "A number of funds were hanging by their fingernails. And just stopping the run or slowing the run was essential."
Still, the veneer of stability ushered in by the insurance program masks what has been a somewhat uneven stretch for the funds, which are typically seen as safe parking places for employers looking to stash payroll funds or parents saving for college tuition. The funds invest in short-term holdings like government securities and certificates of deposit.
Following the implementation of the insurance deal, total assets in money market funds began to climb through January, but since then, the figures have dropped by about 10 percent, with the Federal Reserve's low interest rates driving investors away from the money market and into stock and bond funds. This trend will probably continue until interest rates rise.
Meanwhile, the government continues to monitor the industry, and the Securities and Exchange Commission is currently considering controversial regulatory measures, including one that would ban money market funds from investing in second-tier securities.
This recent regulation is part of a broader trajectory for the funds that just a year ago would have been hard to imagine. Before Lehman Brothers failed, pushing the Reserve Primary Fund's shares below $1, the notion of government insurance would have seemed alien to many money market fund managers. But when investors began fleeing the funds, the prospect that they would quickly recover seemed equally tenuous.
What resulted was an insurance deal born of necessity. "At the critical juncture when it was created ... it was able to provide the additional layer of comfort that investors were looking for in short-term markets," notes Peter Rizzo, senior director of Standard & Poor's Fund Ratings and Evaluations Group. But interest waned toward the end of the year, with some funds dropping out of the program. All told, the insurance initiative earned the Treasury Department roughly $1 billion without costing it a dime in payouts. That's because the Reserve Primary Fund still remains the only money market fund since 1994 to have broken the buck. "It was one of the few government programs that actually made money without costing anything," says Rizzo.
The strength of the insurance program rested in the confidence boost it gave consumers, who were badly shaken at the time. "It was all about stopping the panic," says Crane. "And at the time, the treasury's word was the only one that was any good. Nobody else's pockets were deep enough." But those deep pockets were lined with a number of uncomfortable implications. And now with both unlikely goals—government intervention and market stabilization—achieved, analysts say the time has come for the funds to regain their independence.
Tjornehoj says the lack of a government safety net will encourage funds to make sound decisions. "I think what would bother me about any future regulation of the money market industry is if we don't allow firms to use their good names as a backstop," he says. "As investors and observers, we felt for many years that money market sponsors would stand behind the $1 NAV [net asset value] in the event of a default in their portfolio; they would dig into their own pockets and provide whatever capital was necessary to keep that $1 steady," he continues. "Now, if there's a program that provides for that backstop and essentially lets sponsors off the hook and allows them to just file a claim, then what's to stop them from digging a little bit deeper into the quality spectrum?"
The issue of quality will be on the minds of fund managers a lot in the coming months, not only as they look to the possibility of new SEC regulations but also as they grapple with still-fresh memories of what could have been last year. "I think managers have decided that they don't want to stick their necks out so far to capture the last few pennies of yield, that it just wasn't worth it," says Tjornehoj. But it may take investors a while to trust this pattern. "It's all about reputation, and there, only time can heal those wounds," Crane says.
Still, investor confidence does seem to have rebounded enough that the expiration of the insurance program will not lead to meaningful flight from the funds. "The markets have stabilized to the point where investors aren't as concerned with the short-term markets as they were at that point in time," says Rizzo of last year's panic. "So I don't think it expiring will have any material impact on the industry."
Beyond solid performance, though, further regulation is also a piece of the renewed confidence. Crane estimates that apart from the insurance, 80 percent of the assets that taxable money market funds buy still have some type of recently instituted federal support behind them. "Though the belt is going away, there are still plenty of suspenders," he says.
And if those break, a return to federal insurance is not out of the question. "The die is cast that money markets are too big to fail," Crane says. "If this happens again, they're going to look to the same playbook and say, 'What can we do to back these things?' Because it worked like a charm, even though they jury-rigged the solution. It's like whatever you scored the touchdown with—you've got to be tempted to use that play again."