I had a chat Tuesday with Bruce Bent, the founder and chairman of The Reserve
the Reserve Funds and inventor of the money market mutual fund. I wanted to hear what he thought about the mini-panic in money market funds that began in August, when there was talk that some money funds with investments in subprime mortgage securities might have to “break the buck”–that is, reduce their price per share below $1.
Bent is clearly torn about this. On the one hand, concerns about safety at other money funds have boosted Reserve, which saw its assets rise $10 billion (to $76 billion) in just the past four weeks. On the other, he doesn’t think any funds were really in danger. A few highlights from our conversation:
What happened in August?
Why it blew up to the point that it did is beyond me, because the thing is virtually insignificant. It’s the weirdest thing I’ve seen. I’ve been at this stuff for 46 years and I’ve never seen anything like it.
By “virtually insignificant,” Bent meant that potential losses on subprime loans simply aren’t big enough to matter much to a global markets–and that money market exposure to subprime is much, much smaller.
Should everybody sell every money fund that they’re involved with other than the Reserve Fund because they’re all going to break the buck? The answer is no. I am unaware of any money fund that’s gonna break the buck. This thing is just absolutely ludicrous.
But wasn’t it more about distrust of the valuations of these securities than fear of defaults?
They’re relatively new. They’re not straightforward. But if you think about, literally, if you’ve got an interest in a million people’s trash, and you get the top 1%, I’ve got to believe that you could get 1% of value out of the garbage that you and I and Lem [a PR guy also on the call] and a million other people throw away every day. There is value in anything. …
I buy credit card pools. I think they’re wonderful, because there’s no Enron in there. There’s you and me and Lem and each of us has somewhere between $5,000 and $8,000 in there.
So if some people don’t pay their credit card bills, it’s okay, because the risk is so diffuse. Still, Reserve stayed away from subprime because it knew its customers:
A money fund could go into a subprime and it could take the top tranche from a credit point of view and not have a risk of losing principal, but what they do lose is the commitment to the soundness of the sleep of the investors. …
When you brought in a performance mentality that was geared to stock funds or bond funds into the money funds, the guys that were running the portfolio said we’ve got to have the highest yield. So they turn around and give up better quality, dramatically better quality for an extra 2, 3, 4 basis points. It made no sense whatsoever.
I was wondering how a money fund, which is supposed to invest in short-term securities, could get into mortgages. Bent explained:
Every month when people make payments they make interest and amortization payments, so they will give you first claim on those payments of interest and amortization. … They pledge those to me over next six months or nine months or up to 13 months, and that becomes a money market eligible security. …