Money Market Funds and Breaking the Buck

A money market fund is designed to be the closest thing to cash you can hold while still earning a bit of interest — it invests in very short-term, very safe instruments like Treasury bills and high-grade commercial paper, and is supposed to maintain a stable net asset value (NAV) of exactly $1.00 per share. Investors treat them as cash equivalents precisely because that $1.00 is expected to never move; a fund that keeps its promise is simply a convenient place to park cash overnight or for a few days, used constantly by corporations, other funds, and individuals alike.

"Breaking the buck" means a fund's NAV falls below that $1.00 floor, which happens if the fund's underlying holdings lose enough value that a full dollar can no longer be returned per share. Because investors treat these funds as riskless cash substitutes, breaking the buck is treated as a near-unthinkable event — and when it actually happens, it triggers exactly the kind of panic that a bank run does, because everyone who thought their "cash" was perfectly safe suddenly realizes it might not be, and rushes to redeem before anyone else does.

This happened for real on September 16, 2008, the day after Lehman Brothers collapsed. The Reserve Primary Fund, one of the oldest money market funds, held Lehman commercial paper that instantly became worthless when Lehman failed, and its NAV fell to 97 cents. News of a fund breaking the buck — a genuinely rare, previously almost hypothetical event — triggered a broad run on money market funds generally, as investors everywhere pulled cash out of funds they suddenly worried might have similar hidden exposure, not just the one fund that had actually broken.

The systemic danger was that money market funds are a major buyer of short-term corporate debt (commercial paper), which many large companies rely on to fund routine operations like payroll. As the run spread, funds stopped buying commercial paper to preserve cash for redemptions, which meant the commercial paper market itself started seizing up — a freeze in short-term corporate funding that the Treasury and Fed had to step in directly to stop, first by guaranteeing money fund balances and then by backstopping the commercial paper market, to prevent the panic from cutting off ordinary corporate cash flow across the economy.

The episode is why money market fund regulation was tightened afterward — floating NAVs for institutional prime funds, and redemption gates and fees — all aimed specifically at reducing the incentive to run at the first sign of trouble.