Lesson 10 of 25 · 7 min
Money-market funds, 2008: redemption pressure at scale
When a fund prices at exactly one dollar, the first investor out is paid more than the fund is worth.
A constant-value money-market fund promises redemption at a fixed price, conventionally one dollar a share, while holding short-dated corporate and bank paper whose value is not fixed. The gap between those two facts is usually a rounding error. In September 2008 it stopped being one.
When a large issuer of commercial paper failed that month — the same firm as the previous lesson — funds holding its paper had to write it down. One large fund in the category repriced below a dollar, an event described at the time as breaking the buck. Institutional redemptions from similar funds across the category were reported in the hundreds of billions of dollars within a week. No individual fund is named here, because the mechanism belonged to the category.
The arithmetic of a fixed price creates a first-mover advantage. If the portfolio is worth slightly under a dollar a share and redemptions are paid at exactly a dollar, each departing investor takes a little more than their share, and the shortfall left behind is divided among fewer remaining shares. That is a rational reason to redeem early which has nothing to do with any view on the holdings.
Funds met redemptions by selling the most liquid paper and letting the rest run off, which withdrew the market's bid from commercial paper generally and raised borrowing costs for issuers who had done nothing. A temporary guarantee programme and a central bank liquidity facility followed in the same month, and the rules were later changed to require floating prices and liquidity fees for institutional funds of this type.
A fixed redemption price on a floating portfolio is a queue with a prize at the front of it. The prize is small; the queue is what does the damage.
Key terms
- Constant net asset value
- A fund priced at a fixed figure per share regardless of small moves in its holdings. Convenient, and it hides exactly the gap that matters in stress.
- Breaking the buck
- A money-market fund pricing below its fixed one-dollar share value because its holdings are worth less than that.
- First-mover advantage
- The gain from redeeming before a price adjustment, paid for by the investors who stay. It makes a run the sensible individual choice.
Worked example
Who pays for the write-down
Illustrative figures scaled down so the arithmetic is followable; they are not the reported amounts. A fund with 940,000 shares and $940,000 of assets, holding $12,000 of paper from a defaulted issuer that is written down to 21 cents.
- Write-down on the defaulted paper
- $9,480
- Assets after the write-down
- $930,520
- True value per share
- $0.9899
- 30 percent of shares redeem at $1.0000
- $282,000 paid out
- Value per remaining share
- $0.9856
- Loss borne by those who stayed
- 1.44 cents a share
$12,000 × 0.79.
$930,520 ÷ 940,000.
940,000 × 0.30.
$648,520 ÷ 658,000.
Up from 1.01 cents before the redemptions.
The write-down was 1.01 cents a share. Paying leavers at a dollar turned it into 1.44 cents for everyone left, and the next wave of leavers makes it worse again.
Check yourself
A fund holds 250,000 shares and $250,000 of assets, then writes down $4,500 of holdings to zero. Forty percent of the shares redeem at $1.0000 before the price is adjusted. What is left per share?
Saved in this browser only. No account, nothing sent anywhere.
Educational only. Nothing in this lesson is investment, legal or tax advice, or a recommendation to enter into any transaction. Figures are illustrative and computed from the inputs stated in the lesson.