Reserve Fund Update

Shefali Anand and Diya Gullapalli of the Wall Street Journal [subscription required] report today, "Reserve Fund Will Return $20 Billion to Investors."

We discussed the news item of The Reserve Primary Fund "breaking the buck" over two weeks ago. Today's WSJ report leads us to believe that the fund appears to be making good with it's investors.

By way of background, here's what happened two weeks ago:

The whole imbroglio started when the Reserve Primary Fund, flagship of Reserve Management Corp., announced Sept. 16 that its $1 net asset value had fallen three cents. That was partly due to its investments in Lehman Brothers Holdings Inc., which had filed for bankruptcy protection a day earlier. No money fund had "broken the buck" since 1994, and the news set off a firestorm.

The fund got massive redemption requests Sept. 15 and 16, and finally received an exemption from the Securities and Exchange Commission to suspend payments. Investors have asked to redeem almost the entire $62 billion that was in the fund before the problem hit. Only about $10 billion has been redeemed, said the Reserve spokeswoman.

Here's new information as of today:

The fund said it would redeem $20 billion to investors in the fund as of Sept. 15. As part of a liquidation of Reserve Primary, this move would reimburse investors for 30% to 40% of their original investments. The reason the outlay is $20 billion, a Reserve spokeswoman said, is that this sum is what is "currently available at the fund at this time."

The partial distribution is expected to occur on or about Oct. 13, and will be made pro rata in proportion to the number of shares each investor held as of the close of business Sept. 15. Shares that were tendered for redemption Sept. 15 but weren't paid off will be included in determining shares held by an investor. The fund will repay shareholders in cash, not in its underlying assets, short-term debt holdings.

It isn't clear, however, how much money they will get back for the remaining two-thirds portion -- or how the parent company will pay for this. The reimbursement for the rest may be 97% of the unpaid balance, or less.

Here are some "victims":

The latest casualty from the fund's problems emerged Tuesday with the liquidation of a small Florida health-maintenance organization with 16,000 members. The HMO's money was frozen inside Reserve Primary.

Retail clients were apparently not spared:

Many of those left in the fund are retail clients, including elderly investors in nursing homes, according to a person familiar with the matter. But other bigger institutional or corporate clients are stuck, too.

Finally, there is the inevitable shareholder lawsuit:

Meanwhile, Reserve Primary Fund investors who are stuck in the fund or were cashed out at less than $1 net asset value are fighting in court to force those who got out whole to pool back their money so everyone may share the fund's loss equally.

This is not over yet - stay tuned...

A Word on Vanguard Money Market Funds

In an encouraging sign after the news of the Reserve Primary Fund breaking the buck yesterday, Vanguard Funds came clean today on the state of their money market funds. Their release dated today on their website says:

The recent bankruptcy filing by Lehman Brothers Holdings Inc. and widespread turbulence in the financial markets have prompted a number of questions about the impact on Vanguard funds, including money market funds.

Vanguard is confident in the stability of its money market funds, all of which are managed with the objective of maintaining a stable net asset value of $1 a share. Vanguard continues to manage its money market funds very conservatively and with extreme prudence, focusing on high quality, short-term money market instruments.

All of the investments in our money market funds are closely examined by our Fixed Income Group's highly skilled and experienced credit analysts. Analysts assess the quality of each underlying issuer through in-depth credit analysis and do not rely on agency credit ratings.

Our largest money market fund is Vanguard Prime Money Market Fund, which currently holds more than half of its assets in U.S. Treasury and federal agency securities. In addition, Prime Money Market Fund has no exposure to money market instruments issued by securities dealers, including Lehman Brothers. It also has no exposure to securities of AIG, the insurance concern that is being supported by loans from the federal government.

Holdings of Vanguard Prime Money Market Fund (as of 8/31/2008)
U.S. Treasury: 36%
U.S. Agency: 17%
Certificates of deposit: 32%
High-quality commercial paper: 14%
Repurchase agreements: 1%

Reserve Funds - Primary Money Market Fund Valued at 97 cents on the Dollar

The Reserve Funds' Primary Fund has been revalued at an NAV of $0.97. (Hat tip = CalculatedRisk) The Reserve is considered a pioneer of Money Market funds. The Reserve (Reserve Management Company, Inc.) is also the parent company of Reserve Solutions, the company that recently pioneered the marketing of 401(k) debit card loans.

The press release from The Reserve:

September 16, 2008

The Board of Trustees of The Reserve Fund, after reviewing the unprecedented market events of the past several days and their impact on The Primary Fund, a series of The Reserve Fund and taking into account recommendations made by Reserve Management Company, Inc., the investment manager of The Primary Fund, approved the following actions with respect to The Primary Fund only:

The value of the debt securities issued by Lehman Brothers Holdings, Inc. (face value $785 million) and held by the Primary Fund has been valued at zero effective as of 4:00PM New York time today. As a result, the NAV of the Primary Fund, effective as of 4:00PM, is $0.97 per share. All redemption requests received prior to 3:00PM today will be redeemed at a net asset value of $1.00 per share.

Effective today and until further notice, the proceeds of redemptions from The Primary Fund will not be transmitted to the redeeming investor for a period of up to seven calendar days after the redemption. The seven-day redemption delay will not apply to debit card transactions, ACH transactions or checks written against the assets of the Primary Fund provided that any such transaction from an investor, individually or in the aggregate, does not exceed $10,000. The Primary Fund will continue to accept purchase orders.

Effective tomorrow, September 17, 2008, the NAV for the Primary Fund will be
calculated once a day at 5:00PM, New York time.

...Another Lehman casualty.