Money market funds feeling pain

The money market is supposed to be the safe financial harbor in which cautious investors can wait out market storms or shield short-term funds -- albeit at low interest rates -- needed within a couple of years for a kid's tuition or down payment on a house.

Traditionally, they were invested in short-term government bonds and bank certificates of deposit. But in recent years, in a bid to boost yields, money market funds invested more in short-term corporate debt, known as commercial paper, some of which has gone south amid Wall Street's travails.

This further links, in an uncomfortable way, the ongoing credit crisis with ma-and-pa investors.

"Money market funds are long past the days when they only invested in T-bill and bank certificates," said Peter Crane, CEO of Crane Data, which tracks money market funds. "Now some of the holdings of money funds look more like Cayman Islands front companies."

Money market and brokerage executives would beg to differ.

But the country's largest money market fund, the Reserve Primary Fund, is in trouble because of the erosion in the value of its corporate paper.

And the U.S. Treasury, seeking to stop an investor exodus that was approaching 10 percent of money market assets, this week essentially moved to guarantee funds that were in money markets as of Sept. 19.

Also this week, Ferris Baker Watts, a Washington-based brokerage that was acquired this year by RBC Wealth Management, told clients that it has replaced the Reserve Primary Fund with the Federated Treasury Fund. On Thursday, parent Royal Bank of Canada pledged $35 million to protect clients who invested in Reserve Mangement's Primary Fund.

That should cover the difference between a buck and the Primary Fund's slip to 97 cents per share.

"We are taking this step, in partnership with the investment executives at Ferris Baker, to provide additional protection for the assets of [their] clients," said John Taft, head of Minneapolis-based RBC U.S. Wealth Management.

Several other brokerages and investment management companies, including Legg Mason and Evergreen, have told their investors that they will make up the difference if their money market funds slip below a dollar a share.

Reserve Primary was the nation's single biggest money market fund at $8.4 billion in assets. It plummeted in value thanks to its investments in the commercial paper of bankrupt Lehman Brothers. And a lot of other money market funds that invested in the commercial paper of Fannie Mae, Freddie Mac, American International Group and Bear Stearns would be in trouble were it not for the federal takeovers or assistance to those troubled outfits.

Money funds are designed to be similar to bank accounts. When you put $1 in you expect to get $1 out, including interest at your discretion. It was routine, until the minor panic triggered last week by Reserve -- which invented money market funds in 1970. It "broke the buck" with its Primary Fund that closed at 97 cents a share.

The Primary Fund was caught holding $785 million in worthless paper issued by bankrupt Lehman Brothers.

"A small position in Lehman became a large position as assets left the fund," Peter Rizzo, director of fund services at Standard & Poor's, told Bloomberg.

The Reserve shock caused the run at other funds, until the government stepped in. To keep this vital source of corporate and government credit from drying up, the Treasury announced a one-year, $50 billion backup plan.

At Sit Investment Associates in Minneapolis, the Sit money market fund has more than half of its $71 million in assets in commercial paper. Many money market funds have a third or more of their assets in commercial paper, which helped them pay up to 5 percent interest annually compared with less than half that for bank CDs and short-term Treasury securities.