Money-market funds feel the squeeze

The cascading losses on Wall Street increasingly threaten the safety of investments in money-market mutual funds, which have long enjoyed a reputation for being almost as safe as bank accounts.

Money-market funds aim to invest in low-risk debt issued by the government and healthy corporations, allowing the funds to pay investors a marginally higher interest rate than an average savings account.

But as financial companies move from apparently healthy to definitely dead at ever-increasing speed, some money-market funds have been caught holding investments that are suddenly worthless.

The bankruptcy of investment bank Lehman Brothers, announced Monday, was the latest blow, forcing some fund managers to choose among covering losses with their own money, preserving the illusion of safety, or imposing the losses on their investors.

On Tuesday, for the second time in the 37 years since money-market funds were introduced, a fund manager chose to impose a 3 percent loss on its investors, a decision known in the industry as "breaking the buck." Roughly 20 fund managers this year have chosen to cover losses, the greatest concentration of interventions since the early 1990s.

"Consumers should certainly be paying attention," said Peter Crane, president of Crane Data, which tracks the industry.

The industry has tried to soothe investors. Most of the large funds' managers have issued statements affirming their willingness to cover losses. Several said they had done so this week. Wachovia covered $494 million in losses at three of its Evergreen funds. Northwestern Mutual Life Insurance covered $478 million in losses at two of its Russell funds.

Fidelity Investments, among the largest managers of money market funds, issued a statement that read in part, "We can state unequivocally that Fidelity's money-market funds and accounts continue to provide security and safety for our customers' cash investments."

But investors appear to be fleeing the funds, particularly those who invest in corporate securities. Market analysts said the price of Treasury notes rose sharply earlier this week, in part because of increased demand from investors seeking safe investments.

Money-market funds are carefully designed to mimic bank accounts. Customers can write checks. And the share price is held constant at $1, allowing gains to be reported as "interest" in the form of new shares.

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The safest investments in America are short-term notes from the Treasury or government-insured bank accounts. The basic idea of a money market fund was to offer investors the returns on Treasury notes with the convenience of a bank account.

But almost from the beginning, funds eager to woo investors tried to goose their returns by investing in slightly riskier debt, such as corporate securities.

Over the past 12 months, the Primary Fund posted a return of 4.04 percent, the highest of any of the 2,151 money-market funds tracked by Morningstar. The fund's investments included $785 million in Lehman debt. The results were attracting new investors; the size of the fund more than doubled during the fiscal year ended in March.

Then risk caught up to returns. When Lehman filed for bankruptcy Monday morning, the Primary Fund was forced to take a complete loss on its Lehman investment.

Lawrence White, a professor at New York University, said it was unlikely that other funds would "break the buck," given the industry's stake in maintaining investors' confidence. But he added that the problems again underscored that some investors may have lost a healthy respect for risk in recent years.

"Too many people were not paying attention to the financial riskiness of what they were getting into," White said. "We live in risky times, and this is just another manifestation."

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