Reserves and redemption as legal obligations

Graduate · enrolled learners

This lesson opens with The Reserve Primary Fund breaking the buck, September 2008.

What happened

The Reserve Primary Fund was a large US money-market fund, an instrument designed to hold a stable value of one dollar per share and to be redeemable on demand, much like a stablecoin. To earn a little more yield, it held about 785 million dollars of short-term debt issued by Lehman Brothers. When Lehman filed for bankruptcy on 15 September 2008, the fair value of that debt collapsed, investors rushed to redeem, and the fund became unable to meet their redemption requests. By the close on 16 September its value per share had fallen below a dollar, to 0.97: it broke the buck, something a dollar-stable instrument is never supposed to do. The fund went on to suspend redemptions indefinitely under an SEC exemptive order, freezing investors' access to money they had treated as cash. The pressure did not stay inside one fund: the US Treasury set up a temporary program guaranteeing the share price of eligible money market funds, covering holdings as of 19 September. The SEC later charged the fund's operators with fraud and asked the court to order a distribution of the fund's remaining assets to investors. The fund did not fail because it had no reserves; it failed because its reserves included an asset that was not safe enough, and a dollar-stable instrument cannot hold reserves that can suddenly be worth less than the peg.

The decision point

A dollar-pegged, redeemable instrument, a money-market fund then, a payment stablecoin now, makes two promises that are really one: that it is worth a dollar, and that you can redeem it for a dollar on demand. Both promises depend on the same thing: reserves that are high-quality and liquid enough that they are always worth the peg and can always be turned into dollars to meet redemption. The Reserve Primary Fund is the case that shows what happens when the reserves are not quite that: a reach for yield put a risky asset in the reserves, the asset failed, the value fell below a dollar, and redemption seized up in a run. This is exactly why a stablecoin regime like the GENIUS Act fixes reserve quality and redemption in law: it requires reserves to be held in high-quality liquid assets, cash and short-term government debt, precisely so they cannot suddenly be worth less than the peg, and it requires redemption on defined terms, so the promise to pay a dollar is enforceable rather than hoped for. So the two obligations a stablecoin regime centers, high-quality liquid reserves and honored redemption, are not bureaucratic details; they are the two things whose absence broke the Reserve Primary Fund, written into law so a stablecoin cannot break the same way.

Recorded loss

$785,000,000

Orientation and Year One are open: anyone can read them without an account. From Year Two onward the lessons are for enrolled learners, because progress through the later years only means anything if it is tracked against a record.

It is free. We do not sell the list and there is nothing to buy at the end of it.