When Lehman Brothers collapsed in 2008 and shattered the belief that U.S. money market funds would never break the buck, Washington rushed to limit the damage.
But as Europe's debt crisis threatens to put the U.S. financial system under strain again, U.S. policymakers are worried they cannot turn to those same, impromptu tools to shore up the $2.6 trillion money markets industry.
We've done a lot to prepare the banking sector, Jeffrey Lacker, president of the Richmond Federal Reserve Bank, said on Wednesday. I'm less confident about the money market funds and their ability to weather major problems at European institutions.
Senior U.S. officials are alarmed by the deepening of the European debt crisis. Its spread to Italy, the euro zone's third-biggest economy, is seen as inevitably leading to spillovers across the Atlantic, in part through the holdings of money market funds of European securities.
Many investors believe money funds are as safe as lower-yielding bank accounts even though it is common knowledge that that they are not backed by the federal insurance that protects bank deposits.
During the chaos of 2008, dozens of money funds struggled to maintain $1 per share, but only one, Reserve Primary Fund, reported a net asset value below that level.
Less well known, and of concern to U.S. officials, is that the money funds cannot count on the protection measures that were pulled together to help them in 2008.
NO EASY OPTIONS
The Treasury Department is barred from reprising a guarantee program under the terms of the 2008 bailout of the U.S. banking system. Congress, which agreed to the bailout only reluctantly, prohibited renewing the program on grounds that it was providing a false sense of security to investors who might expect government protection again in the future.
The Federal Reserve is also unlikely to dust off either of two facilities it set up in 2008 to ensure money market funds had cash to meet redemption requests -- the Asset-Backed Commercial Paper Money Mutual Fund Liquidity Facility and the less-used Money Market Investor Funding Facility.
Today's rock-bottom interest rates and the fact that the government would need to charge fees for such guarantees mean that those types of emergency facilities would likely not be effective as a backstop.
Limitations on the Fed's emergency authority -- it can no longer intervene to protect individual firms as it did in 2008, but must provide aid to an entire asset class -- may further cramp the central bank's nimbleness in responding to a crisis.
Another Fed emergency liquidity facility dating from the U.S. financial meltdown depended on a promise that the Treasury would absorb some of the losses if the collateral financial institutions pledged lost value. U.S. lawmakers are now on a debt-cutting crusade and are unlikely to approve more bailout funds for the Treasury to use in that way any time soon.
All this has left some investors nervous about their exposure to what they used to see as the safe havens of money funds, managers said.
Such funds breaking the buck are far and few between, but nowadays, everyone is looking at Europe, and they are seeing things they thought wouldn't happen now happening, said King Lip, chief investment officer at Baker Avenue Asset Management in San Francisco.
The firm manages about $750 million in assets.
He said about 25 percent of the firm's investments are in money markets that had been carefully vetted.
We've had clients asking us to move to cash, Lip said. We're getting more and more requests to move to cash entirely rather than invest in money markets.
Top Fed officials have urged putting money funds on a tighter leash, saying they should be required to hold capital buffers to discourage clients from panic withdrawals.
Given the systemic importance of the money market mutual fund industry, it is critical that one way or another we make the industry less susceptible to credit shocks and liquidity runs, Boston Federal Reserve Bank President Eric Rosengren said in September.
Strains in money funds re-emerged over the summer on concerns about their holdings of commercial paper issued by troubled European banks. Outflows spiked in July as investors worried about the fight in the U.S. Congress over raising the U.S. debt ceiling.
In response, some of the largest funds cut their European bank holdings and shortened the weighted average maturities of the assets they owned. Outflows ultimately stabilized after a debt deal was reached in the U.S. Congress.
Various academics and regulators have backed a shift to a share price that can fluctuate, as opposed to the current money fund practice of guaranteeing a stable $1 per share value. But many companies worry such a change would drive away customers.
Some industry counterproposals involve building up extra capital in some type of buffer to backstop money funds that run into trouble. Asset management executives also say that changes put in place by the Securities Exchange Commission at the start of 2010 already have made the funds much more robust than during the crisis, including tightening credit quality standards and imposing liquidity requirements.
Investors are watching the situation closely.
Evensky & Katz, a registered investment adviser in Coral Gables, Florida, with $700 million in assets under management, is considering whether to pull out of money market funds. But for now, it is leaning toward staying in, said Harold Evensky, the firm's president.
We don't think any of the money market funds we use have significant exposure to Europe and if there was an issue, we have little doubt that they would cover it, he said.
(Additional reporting by Ross Kerber in Boston; Ann Saphir in Chicago; and Ashley Lau and Jessica Toonkel in New York; Editing by Dan Grebler)