It is hard for non-financial types to fully understand the anxiety gripping people who work in finance and experience the ongoing credit crisis. Indeed, it is hard for financial types to understand things that don't involve their own specialty.
Since most people have money funds, this might be a useful illustration of the risks we face now. The funds are supposed to mimic CD's, offering somewhat higher returns with no principal risk. Each share of an MMF is supposed to have a Net Asset Value of $1.00, which makes it possible to write checks on the funds as if they were bank balances.
But a shocking number of funds are at risk of taking losses that would drive the share value under $1.00, exposing the investors in these hitherto safe vehicles to capital losses.
These losses have many sources in these troubled times:
1) sudden and unexpected business failures - AIG, WAMU, Lehman, etc,, and rapid deterioriation in paper such as MBS peddled with government connivance via Fannie Mae and the like, and considered safe investments because of the "implicit" federal guarantee
2) the panicky rise in short term borrowing rates, especially Libor. When interest rates rise, bond prices fall, so the value of MMF investments falls as well.
3) Redemptions by nervous investors moving their money to all US Treasury funds or even to cover living expenses. MMF managers must sell investments to cover redemptions, making bond prices fall and again putting pressure on the $1.00 share target.
Breaking the buck can cause funds to suspend redemptions, contracting the money supply and the general economy, The monetary authorities fear this intensely, and that is one more reason why they push the bailout.
For more information, see:
http://www.thekirkreport.com/2008/09/breaking-the-bu.html
and
http://www.marketwatch.com/news/story/money-market-fund-breaks-buck/story.aspx?guid=56A2CEE5-5A53-4A27-A4BA-585CFBE173A4&dist=SecMostRead
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