Investors pulled more cash out of money-market funds, prompting a second large fund to close to investors, amid concern that these onetime safe harbors are now too risky.
In an effort to stem such withdrawals, the U.S. government Thursday night was working toward taking the unprecedented step of covering money-market funds with a variation of the federal deposit insurance provided to banks.
Until now, the $3.4 trillion money-market-fund industry largely hasn't offered the same type of insurance provided for bank deposits. The plan being discussed likely would cap the amount insured, just as bank accounts are insured up to a certain sum, usually $100,000.
The moves highlight how concerned regulators have become about the rapid outflows from money funds in recent days. Money funds serve as buyers for so-called commercial paper, which companies use to help finance daily operations.
As credit markets locked up world-wide, investors have started moving their cash from money funds to safer locales, such as U.S. Treasurys and bank certificates of deposit. A run on money funds would have implications for corporations that depend on short-term funding such as commercial paper. If the funds don't buy this paper, it could cause a cash crunch, rippling through the wider economy. (See related Credit Markets story.)
Some $78.7 billion was withdrawn from large money funds Wednesday, following a $13 billion outflow Monday and $33.7 billion Tuesday, according to Crane Data LLC. Investors continued to pull money out of some funds Thursday.
Putnam Prime Money Market Fund (Institutional) announced it had closed Wednesday and would distribute assets to customers because of "market-wide liquidity issues." That apparently meant it was having trouble trading the short-term debt instruments in its portfolio due to the credit crunch. The $12.3 billion fund, available only to clients with a $10 million minimum investment, said it held no paper from such problem issuers as Lehman Brothers Holdings Inc., Washington Mutual Inc. or American International Group Inc.
The run on money funds was touched off earlier this week with the closing of Reserve Primary Fund, thanks to its soured Lehman securities. Two-thirds of the Reserve fund's assets were cashed out Monday and Tuesday.
The Reserve offering jolted the investment world when it "broke the buck" -- that is, losses pushed its net asset value below the $1-per-share standard for these funds. In a statement Thursday evening, The Reserve said that investors who want to redeem from its nearly 20 remaining money funds wouldn't get their money back for as many as seven days. It wasn't clear whether investors would be paid $1 per share.
Breaking the buck remains rare. Bank of New York Mellon Corp.'s $22 billion BNY Institutional Cash Reserve Fund, which isn't registered as a money fund, said its net asset value slipped to 99 cents Tuesday, though it says it since has isolated Lehman assets that helped drag it down. Putnam Prime, though, didn't break the buck.
Putnam's board of trustees was to meet to come up with a plan for distribution to customers, mostly corporations and other institutions. Although the plan hasn't been finalized, said Robert Reynolds, the president and chief executive officer of the Boston firm, customers likely will be offered a choice. One choice would be to allow Putnam to sell debt securities in the portfolio over time, in a methodical way, and eventually cash out investors with the proceeds. Or they could get stable debt securities from the portfolio, such as from Bank of America Corp.
Mr. Reynolds, the former Fidelity Investments chief operating officer who joined Putnam 10 weeks ago, said the company became concerned Wednesday when corporate customers began pulling cash from the fund. He said he believed the pressure would get worse.
Departing holders of Reserve Primary Fund could get out Monday at the full $1 per share, Tuesday at 97 cents and after that would have to wait, and may receive much less. A representative for The Reserve said the net asset value hasn't been calculated since Tuesday.
Some of the money in the Reserve fund and others is tied to mutual funds' securities lending. Another source of fund money comes from "sweep accounts," through which brokerage customers' spare cash is automatically deposited in a money fund.
That was the case for Rob Hotchkiss, 47 years old, a founding member of the Grammy-winning band Train. He has about $52,000 stuck in Reserve Primary, because of his sweep account with broker TD Ameritrade Inc. "How much money can I end up losing here?" he asked. A spokeswoman for TD Ameritrade said it is working with The Reserve to redeem client assets.
Unlike Reserve, larger financial companies, like Putnam, are able to bolster their money funds by pumping in capital to maintain the $1 net asset value.
Because of this size advantage, some of the bigger money-fund managers say investors aren't panicking. Vanguard Group and JPMorgan Funds are seeing inflows in their large money-market funds, representatives said.
