Weighing Greece’s Threat to Money Funds

It would take more than one default to “break the buck”

The chance of Greece defaulting on its debt doesn’t pose a danger to U.S. money fund investors—yet. “It would take a very rapid decline, and not just in the smaller European countries” for the debt crisis to inflict losses on U.S. money funds, says George “Gus” Sauter, chief investment officer at Vanguard Group. “You’d probably have to see Spain and Italy get into difficult shape.”

Money funds could be hurt by a default because they hold debt issued by European banks that, in turn, have lent to Greece and other European countries with shaky finances. U.S. money funds that buy corporate debt had about $800 billion, or half their assets as of May 31, in securities issued by European banks, Fitch Ratings estimated. At the end of 2010, European lenders held more than $2 trillion in loans to Greece, Portugal, Ireland, Spain, and Italy, the most indebted European countries, the Bank for International Settlements estimates. “It’s not about whether Greece defaults, it’s what happens after that,” says Alex Roever, head of short-term fixed-income strategy at JPMorgan Chase.

On July 3 euro area finance chiefs approved an €8.7 billion ($12.6 billion) aid payment for Greece—the International Monetary Fund will provide an additional €3.3 billion—and pledged to complete work in coming weeks on a second rescue package to help the cash-strapped nation avoid default.

The bankruptcy of Lehman Brothers led to the closure of the $62.5 billion Reserve Primary Fund on Sept. 16, 2008, when it suffered a loss on Lehman debt. Reserve Primary became the first money-market fund in 14 years to “break the buck”—fail to maintain a net asset value of $1 a share, exposing investors to losses. Customers were denied access to most of their cash for months as the fund liquidated. Fearing that other failures might follow, investors withdrew $230 billion from money market funds in three days. The run threatened to cripple corporations that rely on money funds to buy their short-term debt.

Rules adopted by the U.S. Securities and Exchange Commission after the Reserve Primary debacle would help protect funds if a similar run were to begin now, says Anthony Carfang, a partner at Treasury Strategies, a Chicago firm that advises corporate treasurers. Funds now must keep 30 percent of holdings in securities that can be converted to cash within seven days.

JPMorgan’s Roever and Peter Rizzo, senior director of fund services at credit rater Standard & Poor’s, say U.S. managers have been reducing their European bank holdings and shortening the average maturities of the European debt they do own. Shorter maturities make it easier for funds to raise cash to meet investor redemptions because they can wait for the securities to mature rather than be forced to sell them into a potentially frozen market. S&P estimates that among the 500 U.S. and European money funds it rates, 80 percent of European bank holdings is limited to three months or less, and 95 percent to six months or less. Says Carfang: “A whole lot of very bad things would have to happen very quickly for this to even approach a problem for money funds.”


    The bottom line: New rules would help U.S. money funds, which have about half their assets in European bank debt, survive another crisis of confidence.

    Before it's here, it's on the Bloomberg Terminal.