Correcting the record: The Reserve Primary Fund and the financial crisis
Congress recently considered rolling back certain regulations on money market mutual funds, and in response, American Banker published a BankThink piece, by Better Markets senior policy adviser Lev Bagramian, with the headline “Preserve money market rules to avoid rerun of crisis” (Jan. 12, 2018). The merits of reform aside, the piece omitted some important facts and made some assertions about the Reserve Primary Fund, the “breaking of the buck,” and the run on MMMFs that were incorrect or misleading.
It is now nearly 10 years since the collapse of Lehman Brothers, so for some perhaps memories are a bit hazy. But the actual facts about the Primary Fund and the role of MMMFs in the financial crisis are readily available from public sources.
The errors and these public sources were pointed out to the author and to Dennis Kelleher, the president and chief executive of Better Markets, but they declined to correct the record. We will endeavor to do that here.
First, Mr. Bagramian’s article asserts that “‘breaking of the buck’ panicked large investors into redeeming $40 billion from the fund, forcing the fund to sell tens of billions of dollars in assets immediately.”
In fact, this timeline is backwards. The NAV dropped below $1.00 only after the $40 billion in redemptions. The correct timeline can be found in a court opinion by U.S. Federal District Court Judge Paul G. Gardephe (p. 3-8):
In response to this [Lehman bankruptcy] announcement, on Monday morning, September 15, 2008, the Primary Fund faced a tidal wave of redemption requests. . . . By 3:45 Tuesday afternoon, redemption requests totaled a staggering $40 billion . . . . ”
Efforts [by the Primary Fund] to find a buyer for the Lehman paper were unsuccessful. Accordingly, the full Board of Trustees reduced its valuation of the Lehman debt to zero as of 4:00 p.m. on [Tuesday] Sept. 16, 2008, which caused the Primary Fund’s NAV to drop to $0.97 per share. (Emphasis added.)
In effect, Mr. Bagramian’s timeline places the entire blame for the run on MMMFs on the breaking of the buck. He states that, “This investor run in this one fund quickly became generalized and spread to much of the [MMMF] industry.” It is true that news of the Primary Fund’s NAV created a contagion effect. But other funds were already struggling on Sept. 15, 2008, prior to this news and the Lehman bankruptcy, indicating that something more than events at the Fund was a work. According to a 2013 report by the New York Fed, available here:
Twenty-nine MMFs reported a shadow NAV below $0.995 — low enough to break the buck, absent sponsor support — at some point during [Sept. 15-Oct. 17, 2008]. As many as eleven MMFs on any particular Friday reported shadow NAVs below 99.5 cents, including five funds that reported NAVs below this level before the Lehman Brothers bankruptcy.” (Emphasis added).
Second, Mr. Bagramian’s article asserts that the run on the fund stopped “only after the Treasury Department established the Temporary Guarantee Program to guarantee money market funds.”
Again, the timeline is off. As reported by MarketWatch on Sept. 17, 2008, the run on the Primary Fund came to an end on Sept. 16, when it suspended all redemptions so that it could be liquidated. As the Treasury Department notes here, the TGP program was announced on September 19, 2008.
Third, the article states that, “This [Temporary Guarantee Program] backstopped the entire $3.7 trillion industry, putting taxpayers on the hook for any losses.”
In fact, the TGP did not backstop the entire industry. As The Wall Street Journal reported on Sept. 22, 2008, the Primary Fund, which was the third-largest fund in the industry at the time, was not backstopped.
While it is true that the TGP essentially provided temporary deposit insurance on MMMFs that applied for the program — comprising $3.2 trillion in assets — the extent of taxpayers’ exposure has been inflated. In fact, as noted by a 2009 Congressional Oversight panel, exposure was somewhat limited by the cutoff date, Sept. 19, 2008, meaning that shares sold before then were not eligible for the insurance.
Moreover, as the 2009 Congressional Oversight Panel elaborates, most of the assets in the industry carried minimal credit risk:
Finally, Treasury’s practical exposure was even more limited because a majority of the assets in covered accounts were not subject to real credit risk, including Treasury securities and GSE securities, which both had implicit or explicit federal government backing. (Emphasis added.)
A 2016 paper by Christian McNamara of the Yale University School of Management, available here (page 4), concurs on both the nature of the assets and the effect of the cutoff date. Furthermore, McNamara notes that:
As it turned out, Treasury incurred no costs from claims made under the Guarantee Program and collected $1.2 billion in participation fees. (Emphasis added.)
Fourth, Mr. Bagramian asserts that, “This fire sale [by the Fund] in turn depressed asset values, further weakening the fund.” In fact, other than the Lehman debt, the Primary Fund sold no assets below par. As noted here, the Fund liquidated its holdings at or above par, with shareholders receiving $0.991 per share.
Fifth, Mr. Bagramian’s article makes claims about the effect of the Fund’s marketing that the courts have found to be false. He writes that promotional language left investors “confused at best and misled at worst.” In fact, a federal court found that the SEC “has cited no evidence ... that any shareholders chose to hold their Primary Fund shares . . . because of statements made by Defendants.”
Finally, Mr. Bagramian writes that when the NAV of the Reserve Primary Fund slipped below $1.00, this was, “One of the most consequential threats the American economy has ever faced . . . . ” But if the breaking of the buck was truly the threat that Mr. Bagramian states it was, then there would have been no need to exaggerate its importance by distorting the facts.