US Cavalry rides to the rescue of Money Market funds

Henry PaulsonImage via WikipediaTiming is everything - no sooner had I written about the fallacy surrounding money market funds breaking the buck and the need for regulators to either require fund manager to set aside capital to cover their implicit guarantees or else increase the prominence given to risk warnings, than the US Treasury Secretary, Hank Paulson steps in to underwrite such funds with Government money.

According to Reuters

The Treasury said it would back money market funds whose asset values fall below $1 a share. Separately, the Fed said it would lend money to banks to finance purchases of certain assets from money market funds.
Set to last for at least a year, it is understood that the guarantee is unlimited, transforming US money market funds into a far safer haven than bank deposits, which is sure to delight the banks [NOT!]. Significantly, might this have the unintended consequence of starting a switch of funds out of bank deposits to this new safe haven for anyone with funds exceeding the existing FDIC limits of $100,000 per depositor per bank, especially since money funds typically pay higher rates than bank deposits? Act in haste, repent in leisure?

The Treasury clearly acted to stem a panic and sudden exodus from such funds, current estimated at $3.5trillion, which would have created further havoc in markets. According to reports citing the Investment Company Institute, money-market fund investors withdrew a record $169 billion during the seven-day period that ended Wednesday. This was causing funds to hoard cash and buy Treasury Bills, which drove their yields down to virtually zero. In shunning the commercial paper they typically buy, yields on these assets shot up to 8% and according to the Wall Street Journal, even firms like IBM were paying 6% for money.

Interestingly it is suggested that a fee is going to be levied for this guarantee, without clarifying from whom this is to be collected - fund managers or investors? Likewise, it is unclear whether any investment constraints will accompany the insurance but this would seem reasonable to assume since otherwise reckless funds might invest in excessively risky assets to increase returns, knowing such "bets" were underwritten.

Prior to the announcement, the LA Times reported that
Legg Mason Inc. said it would make $630 million available to its funds to guard against losses, taking a hit against quarterly earnings. The Baltimore-based asset manager had already injected $2.2 billion into seven funds since November to cover potential losses on debt issued by so-called structured investment vehicles.

source Wall Street Journal

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