Reserve Primary Fund

Last updated

The Reserve Primary Fund was the first money market fund that was set up. The investment fund active from 1970 until 2015. The fund was created in 1970 by Bruce R. Bent and Henry B. R. Brown and it was managed by the Reserve Management Company. At its peak it held more than $60 billion in assets. [1] During the financial crisis of 2007-2008 it lost dollar value, or "broke the buck," and was liquidated as a result.

Contents

History

Origin

Until 1980, Federal Reserve Regulation Q limited the rate of interest that banks could pay on savings accounts to 5 percent. This rule was a legacy of the Great Depression, when unsustainable interest rates had contributed to widespread bank failures. When inflation reached 5 percent in 1969, depositors could no longer receive a beneficial real rate of interest. Alternatives to savings accounts at the time included Treasury bills and jumbo certificates of deposit, each of which paid market interest rates but were less liquid than savings accounts and had minimum purchase amounts of $10,000 or more. Seeing an opportunity for arbitrage, Bent and Brown established the Reserve Fund to pool funds and invest them solely in those instruments. [2] In response to this and other arbitrage methods, Congress lifted most of the interest rate limits by 1986.

Failure

In 2006 Reserve Primary made the decision to purchase commercial paper, an asset class that Bent had dismissed as recently as 2001. By early 2008 asset-backed and financial-sector commercial paper made up 56% of its portfolio. The September 15, 2008 bankruptcy of Lehman Brothers raised concern about Reserve Primary's holdings of Lehman-issued paper, which then made up 1.2% of its portfolio, as well as its other financial-sector paper. Among money market funds, Reserve Primary was especially vulnerable due to its lack of a parent company that might be able to guarantee its share price. Demands to withdraw money from the fund reached 25% of its assets by the afternoon and more than half on the following day, as clients sought to exit the fund before its Lehman assets impacted the share price. Unable to find a buyer for the assets, the fund declared them worthless and announced a share price of $0.97. After the Reserve Primary announcement other money market funds also began to experience runs, leading the United States Treasury to halt orders and temporarily guarantee fund share prices. [3] At the end of the month, the fund's managers announced that they would liquidate the fund. [4]

The Securities and Exchange Commission (SEC) sued Reserve Management and its executives for making false assurances to investors about their ability to maintain the fund's value. A federal court awarded the SEC $750,000 from all parties, a small fraction of the requested damages. The court concluded that the misconduct had been an isolated incident in extraordinary circumstances and was not likely to be repeated. [5] A separate investor class action lawsuit was settled for $54 million. [6]

The fund dissolved in December 2015, having paid investors $0.991 per share. [7] [8]

Related Research Articles

Long-Term Capital Management L.P. (LTCM) was a highly leveraged hedge fund. In 1998, it received a $3.6 billion bailout from a group of 14 banks, in a deal brokered and put together by the Federal Reserve Bank of New York.

<span class="mw-page-title-main">Security (finance)</span> Tradable financial asset

A security is a tradable financial asset. The term commonly refers to any form of financial instrument, but its legal definition varies by jurisdiction. In some countries and languages people commonly use the term "security" to refer to any form of financial instrument, even though the underlying legal and regulatory regime may not have such a broad definition. In some jurisdictions the term specifically excludes financial instruments other than equities and fixed income instruments. In some jurisdictions it includes some instruments that are close to equities and fixed income, e.g., equity warrants.

Investment is traditionally defined as the "commitment of resources to achieve later benefits". If an investment involves money, then it can be defined as a "commitment of money to receive more money later". From a broader viewpoint, an investment can be defined as "to tailor the pattern of expenditure and receipt of resources to optimise the desirable patterns of these flows". When expenditures and receipts are defined in terms of money, then the net monetary receipt in a time period is termed cash flow, while money received in a series of several time periods is termed cash flow stream.

<span class="mw-page-title-main">Federal Deposit Insurance Corporation</span> US government agency providing deposit insurance

The Federal Deposit Insurance Corporation (FDIC) is a United States government corporation supplying deposit insurance to depositors in American commercial banks and savings banks. The FDIC was created by the Banking Act of 1933, enacted during the Great Depression to restore trust in the American banking system. More than one-third of banks failed in the years before the FDIC's creation, and bank runs were common. The insurance limit was initially US$2,500 per ownership category, and this has been increased several times over the years. Since the enactment of the Dodd–Frank Wall Street Reform and Consumer Protection Act in 2010, the FDIC insures deposits in member banks up to $250,000 per ownership category. FDIC insurance is backed by the full faith and credit of the government of the United States, and according to the FDIC, "since its start in 1933 no depositor has ever lost a penny of FDIC-insured funds".

The money market is a component of the economy that provides short-term funds. The money market deals in short-term loans, generally for a period of a year or less.

A repurchase agreement, also known as a repo, RP, or sale and repurchase agreement, is a form of short-term borrowing, mainly in government securities. The dealer sells the underlying security to investors and, by agreement between the two parties, buys them back shortly afterwards, usually the following day, at a slightly higher price.

Rational pricing is the assumption in financial economics that asset prices – and hence asset pricing models – will reflect the arbitrage-free price of the asset as any deviation from this price will be "arbitraged away". This assumption is useful in pricing fixed income securities, particularly bonds, and is fundamental to the pricing of derivative instruments.

A money market fund is an open-end mutual fund that invests in short-term debt securities such as US Treasury bills and commercial paper. Money market funds are managed with the goal of maintaining a highly stable asset value through liquid investments, while paying income to investors in the form of dividends. Although they are not insured against loss, actual losses have been quite rare in practice.

A collateralized debt obligation (CDO) is a type of structured asset-backed security (ABS). Originally developed as instruments for the corporate debt markets, after 2002 CDOs became vehicles for refinancing mortgage-backed securities (MBS). Like other private label securities backed by assets, a CDO can be thought of as a promise to pay investors in a prescribed sequence, based on the cash flow the CDO collects from the pool of bonds or other assets it owns. Distinctively, CDO credit risk is typically assessed based on a probability of default (PD) derived from ratings on those bonds or assets.

The following outline is provided as an overview of and topical guide to finance:

A structured investment vehicle (SIV) is a non-bank financial institution established to earn a credit spread between the longer-term assets held in its portfolio and the shorter-term liabilities it issues. They are simple credit spread lenders, frequently "lending" by investing in securitizations, but also by investing in corporate bonds and funding by issuing commercial paper and medium term notes, which were usually rated AAA until the onset of the financial crisis. They did not expose themselves to either interest rate or currency risk and typically held asset to maturity. SIVs differ from asset-backed securities and collateralized debt obligations in that they are permanently capitalized and have an active management team.

<span class="mw-page-title-main">Financial market participants</span>

There are two basic financial market participant distinctions, investors versus speculators and institutional versus retail. Action in financial markets by central banks is usually regarded as intervention rather than participation.

Henry Bedinger Rust Brown was an American financial consultant known for inventing the world's first money market fund, the Reserve Fund, with Bruce R. Bent in 1970.

This article provides background information regarding the subprime mortgage crisis. It discusses subprime lending, foreclosures, risk types, and mechanisms through which various entities involved were affected by the crisis.

The U.S. central banking system, the Federal Reserve, in partnership with central banks around the world, took several steps to address the subprime mortgage crisis. Federal Reserve Chairman Ben Bernanke stated in early 2008: "Broadly, the Federal Reserve’s response has followed two tracks: efforts to support market liquidity and functioning and the pursuit of our macroeconomic objectives through monetary policy." A 2011 study by the Government Accountability Office found that "on numerous occasions in 2008 and 2009, the Federal Reserve Board invoked emergency authority under the Federal Reserve Act of 1913 to authorize new broad-based programs and financial assistance to individual institutions to stabilize financial markets. Loans outstanding for the emergency programs peaked at more than $1 trillion in late 2008."

The interbank lending market is a market in which banks lend funds to one another for a specified term. Most interbank loans are for maturities of one week or less, the majority being overnight. Such loans are made at the interbank rate. A sharp decline in transaction volume in this market was a major contributing factor to the collapse of several financial institutions during the financial crisis of 2007–2008.

<span class="mw-page-title-main">Public–Private Investment Program for Legacy Assets</span>

On March 23, 2009, the United States Federal Deposit Insurance Corporation (FDIC), the Federal Reserve, and the United States Treasury Department announced the Public–Private Investment Program for Legacy Assets. The program is designed to provide liquidity for so-called "toxic assets" on the balance sheets of financial institutions. This program is one of the initiatives coming out of the implementation of the Troubled Asset Relief Program (TARP) as implemented by the U.S. Treasury under Secretary Timothy Geithner. The major stock market indexes in the United States rallied on the day of the announcement rising by over six percent with the shares of bank stocks leading the way. As of early June 2009, the program had not been implemented yet and was considered delayed. Yet, the Legacy Securities Program implemented by the Federal Reserve has begun by fall 2009 and the Legacy Loans Program is being tested by the FDIC. The proposed size of the program has been drastically reduced relative to its proposed size when it was rolled out.

<span class="mw-page-title-main">2007–2008 financial crisis</span> Worldwide economic crisis

The 2007–2008 financial crisis, or the global financial crisis (GFC), was the most severe worldwide economic crisis since the Great Depression. Predatory lending in the form of subprime mortgages targeting low-income homebuyers, excessive risk-taking by global financial institutions, a continuous buildup of toxic assets within banks, and the bursting of the United States housing bubble culminated in a "perfect storm", which led to the Great Recession.

United States policy responses to the late-2000s recession explores legislation, banking industry and market volatility within retirement plans.

An asset-backed commercial paper program is a non-bank financial institution that issues short-term liabilities, commercial paper called asset-backed commercial paper (ABCPs), to finance medium- to long-term assets.

References

  1. ↑ "The Reserve to give back $1B to Primary Fund investors". Associated Press. Sep 23, 2009.
  2. ↑ Nocera, Joe (2013). A Piece of the Action.
  3. ↑ Akay, Ozgur; Griffiths, Mark D.; Winters, Drew B. (2015). "Reserve Primary: Fools Rush In Where Wise Men Fear to Tread!". Journal of Investment Management. 13 (1).
  4. ↑ "Important Notice Regarding The Reserve Primary Fund" (PDF). September 29, 2008. Retrieved 2019-10-25.
  5. ↑ Raymond, Nate; Stempel, Jonathan (September 30, 2013). "US judge awards $750,000 in case of money fund that 'broke buck'". Reuters. Retrieved 2019-10-22.
  6. ↑ Raymond, Nate (September 6, 2013). "Settlement reached in Reserve Primary Fund lawsuit". Reuters. Retrieved 2019-10-28.
  7. ↑ "Court approves final distribution" (PDF). September 23, 2014.
  8. ↑ "Termination of Primary Fund–In Liquidation" (PDF). November 4, 2015.
This page is based on this Wikipedia article
Text is available under the CC BY-SA 4.0 license; additional terms may apply.
Images, videos and audio are available under their respective licenses.