by James Copenhaver, Director of Investment Management,
Wealth Enhancement Group

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 to become a major rival to the banking system, with $3.5 trillion in assets. It had weathered crises such as the Asian currency mess of the late 1990s and the fall of hedge fund giant Long-Term Capital Management. Though some were talking there wasn't a feeling of impending disaster.

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.

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.

Events of September 2008 Sept. 15 – Lehman Brothers declares it will file for bankruptcy after government and industry efforts to save it collapse. Sept. 16 – U.S. officials agree to bail out American International Group. Sept. 22 – The Federal Reserve approves emergency bank holding company applications for Goldman Sachs and Morgan Stanley. Sept. 25 – Washington Mutual fails; largest bank failure in U.S. history. Sept. 29 – FDIC agrees to help Citigroup acquire Wachovia, and House of Representatives defeats initial bank bailout proposal. Citigroup/Wachovia deal unravels several days later. Oct. 3 – President Bush signs into law $700 billion financial market bailout package.

In the space of just two days -- Sept. 17 and Sept. 18 -- $210 billion was redeemed from institutional prime money-market funds.

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.

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.

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.

A year of trouble ahead

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.
Source: MarketWatch, Sam Mamudi

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