Money market mutual funds were created in 1970 to allow small investors to pool assets to gain access to short-term, higher yielding US government bonds. At the time, government bonds were paying about 3% more than savings accounts, but could only be acquired in ten-thousand dollar increments. The funds were priced at a dollar per share and while they were not backed by government nor insured by the FDIC, they were considered safe.
As the industry evolved and government bond yields dropped, many money market funds expanded their investments to include commercial paper, the short-term debt that companies use to fund their on-going operations. That's where our story last year begins.
The Reserve Management Company was one of the oldest money market providers. The firm's founder, Bruce R. Bent, Sr., is credited with co-inventing the concept in 1970. The Reserve had been known as one of the most conservative companies, shunning commercial paper. But in 2006, prodded by his son Bruce Bent II, Reserve added commercial paper - including the paper of Lehman Brothers - to its money market holdings, in order to increase its yield and attract more assets into the fund.
When Lehman Brothers went bankrupt, its commercial paper was rendered worthless. That meant that the $785 million of Lehman commercial paper in the Primary Reserve Fund (approximately 1.2% of the fund's holdings) had to be marked down. Because of Lehman's failure, the value of a share of the Primary fund was no longer $1 per share. After the market closed on September 16th, 2008, the Primary Reserve Fund was valued at $0.97/share, known as "breaking the buck".
The news caused Investors in all mutual funds to panic and rush for the exits. To halt the run on money market funds, on September 19, 2008, the US Treasury announced that it would issue a temporary guarantee of money market funds. Investors found great solace in this decision.
A year later, most people probably forgot all about the government guarantee. Funny how time and recovering asset values can do that to an investor.
The lesson of the money market chapter of the melt-down is that money market funds are not savings accounts, which are backed by the FDIC, nor are they Treasury bills, notes and bonds, which are backed by the full faith of the US government. Money market funds are risky cash vehicles. Perhaps by lifting the guarantee on mutual funds, the government is conceding that very point.