The Credit Crunch Hits Money Funds (Again)

Will the credit crunch decimate money-market funds next?

Money-market funds are considered one of the safest places to park cash. But that, like everything else in this wild market, is being challenged. The Reserve Fund, one of the most esteemed players in the money fund industry got caught holding Lehman Brothers short-term debt. (Ironic, since founder Bruce Bent is known as the person who democratized money funds for the masses.)

After the Reserve Fund broke the buck, investors started fleeing from money-market funds, which are not guaranteed or backed by the FDIC.

The ripple effect? Panic selling. Today Putnam Investments closed an institutional money fund to meet selling because its shareholders are chucking money funds for short-term Treasuries and other “safe” investments.

“The big unknown is what redemptions (other money funds) are facing,” says Karen Dolan, a Morningstar analyst. “Everyone goes ahead, tries to play it safe, and sells.”

Indeed, I know three people who have yanked their cash out of money-market funds this week and put it in certificates of deposit.

Dolan notes that it is very difficult to discern what is lurking in your money-market fund. She praises fund companies like Fidelity Investments, which have kept shareholders up-to-date by posting portfolio holdings online. (Dolan authored this piece on money-market fund risks yesterday.)

I also checked in with Vanguard Group Thursday, and they say they don’t hold any toxic stuff. In fact, Vanguard is a beneficiary of the mess, reporting inflows into money funds today. “We have ample liquidity,” says spokeswoman Rebecca Cohen, noting that half of the $106 billion vmmxxis invested in Treasuries and government agencies.

Yet-another wrinkle is the rumor going through the market that a Bank of New York Mellon money fund broke the buck. The fund in question is the BNY Institutional Cash Reserve Fund. Bank of New York spokesman Kevin Heine says that private, specialized fund “is part of our securities lending program and is limited to securities lending clients only.” The fund represents less than 1% of the bank’s total securities lending, he notes.

Even so, in a market dominated by panic and rumors, news that money funds are failing makes people nervous.

Money-market funds have $3.5 trillion in assets. If the contagion spreads, it will be far worse than the $330 billion auction-rate securities debacle.

Update: News that the government plans to guarantee money-market fund investments is an excellent solution.

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