by Reb Akiva at Mystical Paths
I saw a financial headline on Thursday that I didn't understand. It was "Putnam Investments closed its $15 billion Prime Money Market Fund" with no further info at the time. This was odd, funds normally close because they're "full", they've reached the money capacity of the investment scheme they have in mind. But that's not news, it's normal. So why was this HEADLINE BREAKING FINANCIAL NEWS? Now I've seen an article explaining, and you need to know...
First a little background. Banks don't actually have your money, they just keep a small portion - called the reserve - for handling day to day money requests. The rest they loan out or invest or do business with. That's how banks make money, by renting out your money.
Similarly, mutual funds also don't have your money. In the case of stock funds this is obvious, they have your money in stocks and keep a small cash buffer for immediate withdrawal requests, selling the stock they hold for you to cover the rest. But it turns out "stable" mutual funds ALSO don't have your money. It was assumed they do since they invest in cash instruments - meaning since they hold treasury bonds, bank CDs, and high value corporate bonds, things considered 'cash equivalents' that they could not loose value and always instantly be easily redeemed (returned from equivalent to actual cash).
(CNBC) U.S. money management firm The Reserve said on Friday two of its funds have filed an application with the U.S. Securities and Exchange Commission asking to be allowed to suspend or delay redemption requests due to a massive rush by investors to withdraw their money.
Reserve said its $62 billion Primary Fund has received redemption requests for about $60 billion this week. The firm asked the SEC for the right to suspend redemptions from both its Primary Fund and its U.S. Government Fund in order to protect the funds' shareholders.
U.S. asset manager Putnam Investments said on Thursday that it had closed its $15 billion Prime Money Market Fund due to significant redemption pressure.
This is a classic bank run. Everyone goes for their money, the bank doesn't actually have more than about 10%. In this case, everyone goes for their mutual fund money and it can't redeem the cash instruments fast enough to cover the demand. And worse, in trying to do so, they flood the market and the cash instruments become worth LESS THAN CASH...
The normally rock-solid reputation of money funds—which typically invest in short-term debt such as government and corporate bonds— took a major hit Tuesday when the value of Primary Fund RFIXX shares fell below the $1 benchmark for the funds. The phenomenon, generally known as "breaking the buck," means that holders in that fund actually lose money.
This is not a minor deal. Funds that are trying to stop paying, funds that can't sell their cash instruments fast enough to redeem, and funds who can no longer get $1 for their $1 _high quality_ cash instrument.
THIS is why the US government and central banks around the world are reacting so strongly. This flood either stops now, or these major cracks in the system turn into full fledged breaks.
Updated: How close to a true financial meltdown have things been? "ALMOST ARMAGEDDON, MARKETS WERE 500 TRADES FROM A MELTDOWN"
Free Home Delivery! - From Mystical Paths,
Sunday, September 21, 2008
// 9/21/2008 //