The Moral Hazard of Money Market Fund Madness
Here we go again:
Forget for a moment the IMF, and instead direct your gaze upon the MMF: Money Market Funds. These are a type of mutual fund that is, according to the SEC, required by law to invest in low-risk securities. They pay dividends that are supposed to reflect short-term interest rates. They are not (repeat NOT) federally insured.
Except they were.
Recall that during the credit crisis, these supposedly uninsured, supposedly low risk vehicles for squeezing a few pennies more out of cash fell below their One Dollar ($1) benchmark. When that happened, the Fed and Congress rescued them with a bailout as well.
Why on earth taxpayers were on the hook for an investment 3rd parties made is beyond my comprehension. Investors in equities were not made whole for their losses, that is the chance they took. Investors in bonds were not made whole, unless they were clever enough to lend to banks. Despite the foolishness and bad investment judgment of creditors to Bank of America, Citigroup, Bear Stearns, etc. were made whole.
The idea of systemic risk sure comes in handy from time to time.
And guess what? It appears that we are once again, looking at systemic risk of the banks and money market funds, who once again, made some very ill-advised lending. Only this time, instead of giving money to home buyers who could not possibly ever pay it back, they lent money to Countries, who could not ever pay it back.
Here is Randall Forsyth in this morning’s Barron’s
“RETURN-FREE RISK.” That’s just one of the turns of phrase that Jim Grant has tossed off over the years as editor of the invaluable Grant’s Interest Observer and as Barron’s most illustrious alum.
The term could well apply to major money-market funds, which provide yields barely visible to the naked eye but could suffer collateral damage from any potential fallout from a possible default by Greece. Grant was way out ahead of the crowd by pointing out in his latest issue, dated June 17, that the five largest money funds, Fidelity Cash Reserves (FDRXX), Vanguard Reserve Prime (VMRXX), Fidelity Institutional Money Market Market Portfolio (FNSXX), Fidelity Institutional Prime Money Market Portfolio (FIPXX) and BlackRock Liquidity TempFund (TMPXX) held an average of 41% of their assets in European banks’ short-term debt. Fitch Ratings added in a report last week that the top 10 money funds, with assets of $755 billion, had about half their assets in European bank liabilities.
It’s doubtful that any money-fund holder has forgotten the aftermath of the Lehman Brothers bankruptcy in 2008, which caused The Reserve Fund, a pioneer in the field, to “break the buck” — have its net-asset value fall below $1 a share — owing to its holding of Lehman commercial paper. Since the crisis, the Securities and Exchange Commission has mandated money funds hold at least 10% of their assets in paper that can be converted into cash in one day and 30% in paper due in 60 days or less (or redeemable within seven days).
European Central Bank President Jean-Claude Trichet last week declared the financial risk situation was “code red.” That was his characterization of an assessment by Europe’s new risk monitor, the European Systemic Risk Board, that the highly interconnected financial system inside and outside the European Union means debt woes of several countries could spread rapidly if conditions worsen, the Associated Press reported.
Given that, money funds with European exposure and yielding about 0.01% would seem the very embodiment of return-free risk. But it seems the generals have prepared well for the last war, so 2008-style runs aren’t likely.
It appears that once again, bankers have shown themselves to be incapable of assessing risk properly. And why should they? Every time they screw up, most of them get rescued, while a tiny percentage are allowed to ignominiously whither and die.
The lesson these banks have learn is not to be more prudent with their risk taking, but rather, to make sure they are not amongst the smallish group of financiers who are unconnected in DC. The credit crisis taught them that Risk Management is for Suckers, and the real money s in pol;itical lobbying and owning a Congressman or two.
Moral Hazard anyone?
>
Source:
Show Ralph the Money
RANDALL W. FORSYTH
Barron’s, JUNE 25, 2011
http://online.barrons.com/article/SB50001424053111904548404576397770227805578.html
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June 25th, 2011 at 8:58 am
Wow, I bet a congressional subcommittee will look into this asap, right after they finish their work on the ‘Panic of 1857’ (exacerbated by that new technology, the telegraph and viewed as “… the first worldwide economic crisis”)
http://memory.loc.gov/ammem/today/aug24.html
Early Insider trading???
“Harper’s Weekly for September 12, 1857, took a dim view of dealings on the New York Stock Exchange. They claimed that the greed of speculators underlay the panic and gave examples that included the following:
…Jones believes that we are going to have a “crisis,” a “revulsion,” and “panic.” Or Jones is treasurer of the New Gauge Railway, and having access to the books, knows that it is insolvent. In both these cases Jones directs his broker to sell for his account so many shares of the New Gauge Railway…retaining the right of delivering the stock on any day he pleases prior to the conclusion of the contract. Of course, Jones doesn’t own the stock he sells; he intends to buy it at a reduced price at the time he delivers. Now, if Jones has been right in his prognostications — if the panic and crisis do come, or if the New Gauge Company does turn out to be insolvent, of course the stock goes down, and Jones buys in for delivery at the reduced price, realizing the difference between that price and the one at which he sold. But if Jones has been wrong — if the crisis don’t come, or is unduly postponed — such things have been known to occur — if the New Gauge concern should prove profitable, and not insolvent, why then the stock might go up, and at the end of the contract Jones might be forced to buy for, say $50, that which he sold at $45 — netting a loss of $5 per share.”
June 25th, 2011 at 9:19 am
I’m not sure what the solution is for money market funds. They are the original shadow banking system. They are unquestionably vulnerable to runs. If investors decided to head for the exits because of exposure to shaky financial CP, even creditworthy CP issuers might not be able to roll CP. And in a real panic environment like 2008, other credit might also be hard to come by, leading to either insolvencies or unsavory bailouts.
As you mention, despite some hand-wringing, a run doesn’t seem too likely. Anyone left in MM funds is probably relatively sophisticated, since individuals can get 1% on FDIC-insured deposits up to $250,000. A lot of those European banks like BNP and Soc Gen with big Greek exposure really are too big to fail, and there are a number of Euro banks without big Greek exposure. (see http://ftalphaville.ft.com/blog/2010/04/28/214661/whos-exposed-to-greece-iii/ ) One would hope that the money market fund PMs and rating agencies are smart enough to tell the difference and avoid institutions with big exposures.
Requiring liquidity makes sense. Big black-letter disclosures on MM fund paperwork that they are not insured, might break the buck and might have to limit withdrawals would be good. Maybe floating the NAV is worth looking at to provide daily reminders that you can make or lose money. Maybe a non-government insurance scheme, but clearly wouldn’t work at current interest rate and risk levels.
Unless you’re ready to go back to a fully regulated world where only banks can offer MM type products with deposit insurance, or a laissez faire world that doesn’t do bailouts and lets the cards fall where they may (ha!), some degree of instability and moral hazard are here to stay.
June 25th, 2011 at 9:23 am
Not only do they get rescued, they get rewarded, Pavlonian, please give me another crisis so I can get a taxpayer backed reward. Crony capitalism at its finest. Let’s continue to incentivize crisis. You can hardly blame the poor little banksters.
June 25th, 2011 at 9:32 am
So Barry, if everyone cashes out of their MM funds and puts the money into FDIC bank accounts what are the consequences to the financial system?
This story is a complete waste of time because it fails to address consequences of major changes in the MMs, should they occur.
Have a good weekend Barry.
June 25th, 2011 at 9:56 am
As usual, Jon Stewart nails it
http://www.thedailyshow.com/watch/wed-june-22-2011/grecian-burn—credit-default-swaps
June 25th, 2011 at 9:57 am
FYI: For those who fear that the Fed may not backstop the MMF’s again, American Century’s aptly named Capital Preservation Fund invests 100% in Treasuries and is, I believe, one of the few and perhaps the only such fund still accepting new money without restriction.
June 25th, 2011 at 10:12 am
“The credit crisis taught them that Risk Management is for Suckers, and the real money s in pol;itical lobbying and owning a Congressman or two.”
The credit crisis taught then that? Sorry BR. Anyone paying attention was taught that by Sandy Weill.
http://www.nybooks.com/articles/archives/2011/jul/14/busts-keep-getting-bigger-why/?pagination=false
June 25th, 2011 at 10:27 am
So what happens to Treas based MMkt if the critters decide to risk default of the US? (or appearance of default)
June 25th, 2011 at 10:30 am
make that non-FDIC Treas based MMkt
June 25th, 2011 at 12:13 pm
Yet another reason why we will have to bail out someone else.
If we don’t bail out entity “X”, we’ll have financial armageddon.
If we don’t bail out entity “Y”, there won’t be any money in the ATM machines.
If we don’t bail out entity “Z”, the world will come to an end.
June 25th, 2011 at 12:26 pm
AnnaLee asks: “So what happens to Treas based MMkt if the critters decide to risk default of the US? (or appearance of default)”
Stock up on bottled water, canned goods and dried beans. A musket, lead, charcoal, sulfur and sodium nitrate might help as well. The heads of wooden matchsticks can be used to ignite your homemade black powder.
June 25th, 2011 at 12:43 pm
Interesting the MM stories start rearing again as the US is heading for technical default and QE2 is ending…..an attempt to shore up demand for US Treasuries? What to do? Should I be opening that Bank of China yuan account, Swiss franc, Gold? I picked a bad decade to stop sniffing glue.
June 25th, 2011 at 1:43 pm
Here is the monthly holdings report for Fidelity Cash Reserves (top, right):
http://goo.gl/Tf92c
Thanks for highlighting this, Barry.
June 25th, 2011 at 2:13 pm
I’m not sure if ‘the Real’ of it has been mentioned..
seems to me that the ‘Bailout’, of the MM Fundz, was a ‘Bailout’ out of the Whole MutFund/”Investment” Company Complex..
J&J (now, 4-)Pack (aka Mr. & Mrs. MutFund (di-)vestor) would have, surely, Thought again, or, for the First Time, about the Whole “401(k)”/”Retirement”-Charade, if the ‘simplest’ of “Investments”–the MM Fund, sold to them as “Good as Cash”, came a cropper..
Startling the Herd, in such a Fashion, would, obviously, been “bad for ‘Business’”…
~~
viewed through a different lens.. “…An inadequate water supply can depress milk yields. Ensure that water is cool and is available in sufficient volumes to satisfy the cow. A dairy cows appetite for water can be satisfied long before it has reached its capacity for water, so if the water is slow to come through to the trough, the cow may be quite contented, but its milk yield can be down by 25%…”
http://www.kzndae.gov.za/AgricPublications/ProductionGuidelines/DairyinginKwaZuluNatal/AppliedRuminantNutritionforDairyCows.aspx
June 25th, 2011 at 3:34 pm
Any individual banker could have exercised more prudence by avoiding these European securities, but where else could the entire industry have placed these $trillions of deposits? What would be the $trillions worth of safe securities? Are American banks safer? Seems to me the European banks are not necessarily the riskiest security available.
In my view, the blame for “return free risk” rests solely on the shoulders of the Federal Reserve which has chosen to recapitalize the banking system, through zero short term rates, at the expense of the saver.
In light of the recent bailout of banksters and speculators, what is the likelihood that will grandma’s money market won’t get bailed out?
June 25th, 2011 at 4:31 pm
Yipee!!
Another opportunity to experience a total blowout, which seems to be the only occasion when the cluster of fuckheads inhabiting Versailles-on-the-Potomac are forced to learn something that can be useful to the common good instead of their cronies.
This, or the Sharron Angle Admonition will need to become the Law of the Land.
June 25th, 2011 at 5:35 pm
The saver is Grandma. I don’t think they would have any problem letting Grandma’s MM fail, to the extent they were out.
June 25th, 2011 at 9:10 pm
The last twenty years have really been a lesson in wealth. The 90s taught us that owning a share of the corporate world could not be considered wealth. After all, when people saw their stock portfolio’s soar in value, they were chided and warned that this was not wealth, and, indeed, when the bubble burst, most people lost big. The 00s taught us that owning a house and plot of land could not be considered wealth. After all, when people saw the value of their real estate soar in value, they were chided and warned that this was not wealth, and, indeed, when the bubble burst, most people lost big.
So, what is wealth? It seems to be owning a piece of Congress or some other branch of the government, so that when the bubble bursts, you get covered, even when the other poor suckers take a bath. The private sector just doesn’t seem to have much to do with wealth as the only true wealth is government connections and influence. Maybe you should start a fund that invests in Congressmen or maybe the voters should stop buying the party line.
June 25th, 2011 at 10:20 pm
@kaleberg
really, you’re good boy (evidenced, here, by: what is wealth? , at the min.)
“…could not be considered wealth…”
“…could not be considered wealth…”
as the ol’ adage reads..”If you’re not Selling Drugs & Buying Politicians, you’re in the Wrong ‘Business’..”
It, really, is Old.
w/ that, We may do Well to wonder..
“Who Lights the Lamp?”
“Who constructs ‘the Shining City upon the Hill?”
et al., etc…
you know, ‘for a Change’ (??)